In significant ways, 2025 marked a break of the geopolitical alignments that have been in place for most of the post-war period. Tariffs imposed by the United States against allies, such as Canada and the European Union, were one manifestation of this. The reactions of the financial market and the respective economy to these events were quite interesting. Equity markets in Canada and most of the countries that make up the European Union (EU) performed very strongly in 2025 and are off to good starts in 2026. Moreover, both the euro and the Canadian dollar appreciated against the U.S. dollar in 2025.
Equity markets in Canada and most European countries outperformed U.S. markets in 2025. In spite of Canada’s vulnerability to American tariffs, Canadian equity markets turned in one of their best performances in more than 15 years, with the main benchmark index rising by almost 30%. Many countries within the EU did very well, too. Spain’s equity market was up about 50%, Italian stocks rose 30% to 42%, depending on the index, and Germany saw increases in the 20% to 30% range. Greece, Poland, the Czech Republic, Austria, and Hungary also saw very strong gains. UK markets turned in their best gains since the 2016 Brexit referendum.
U$D and the world economy
According to standard economic models and past experiences, the Trump tariffs should have led to an appreciation of the U.S. dollar (USD). However, this did not happen in 2025:
- The USD fell by 14% against the euro.
- The USD fell by 5% against the Canadian dollar.
- The USD fell by 8% against the British pound.
The Federal Reserve’s Nominal Broad Dollar Index fell by over 7%. The dollar weakened against the euro, Canadian dollar, and the pound despite the relevant central banks cutting rates by more than the Federal Reserve did in 2025. The most straightforward way to reconcile these developments (tariffs and a weakening of the dollar) is a shift in investor preferences away from dollar-denominated assets and toward non-dollar assets in 2025. It could be that investors concluded that the United States was becoming a riskier place to invest, perhaps due to the erosion of long-held assumptions about its institutions.
Is the global economy recalibrating the post-WWII alliance system?
Beyond this institutional reassessment, other factors likely came into play. Before 2025, U.S. equity markets had strongly outperformed their European counterparts. It could be that investors found more attractive valuations outside the United States. Another factor is an ongoing shift toward more expansionary fiscal policy in Europe. Much of this is tied to the realization (with the war in Ukraine now in its fourth year) that Europe needs to increase defense spending.
Another possibility is that the markets do not view the events of the past year as a definitive breakup of the post-war alliance system. Perhaps there is even room for an optimistic interpretation that the events of 2025 provide a beneficial recalibration. Although individual personalities matter and sometimes overshadow everything else, alliances are ultimately rooted in the national interest of the countries involved. The post-war system, including its economic arrangements and institutions, has facilitated a long period of economic prosperity in much of the world. A compelling argument for ditching it has yet to be articulated.
The markets may be taking a long view of the contentious events that have characterized 2025 and the first month of 2026 or, r perhaps, are engaging in some wishful thinking. Time will tell. The combination of booming equity markets and currency appreciation in Canada and most of Europe is a striking development. Perhaps the sound and fury of the past year signifies less than they appear to. Markets are not always right, but the preliminary verdict has been favorable for the economy in Canada as well as in Europe.
