Dollar Consolidates After Yet Another Tariff Story

January 14, 2025
  • Another day, another speculative report on tariffs; the dollar weakened on this report but we don’t think it’s a negative; December inflation data will be the highlight; New York Fed inflation expectations for December were mixed; NFIB small business optimism jumped again in December
  • There are still some hawks at the ECB; Italy reported December IP; the BOE continues to face a policy dilemma
  • BOJ Deputy Governor Himino spoke; Japan reported November current account data; Australia Westpac–Melbourne Institute Consumer Sentiment Index dipped in January; New Zealand Q4 business outlook survey was mixed; China reported solid December new loan and money supply data

The dollar Is consolidating after yet another report on tariff policy. DXY is trading lower for the first time since last Monday near 109.581 after making a new high for this cycle near 110.176 yesterday. We’d downplay the tariff noise (see below) and view this dollar dip as a buying opportunity. Sterling continues to underperform and is trading lower near $1.2190 after trading at a new low for this cycle near $1.21 yesterday. It remains on track to test the October 2023 low near $1.2035. Elsewhere, the euro is trading higher near $1.0260, while USD/JPY is trading higher near 157.90 despite hints that the BOJ may hike this month (see below). More tariff noise is likely in the coming days and weeks but we continue to look through that and focus on the underlying fundamental backdrop, which remains unchanged. Simply put, the strong U.S. fundamental story of strong growth, elevated inflation, and a more hawkish Fed continues to favor higher U.S. yields and a stronger dollar. This week’s inflation and retail sales data should underscore this message.

AMERICAS

Another day, another speculative report on tariffs. Late yesterday, reports emerged suggesting members of Trump’s incoming economic team are discussing a gradual approach to tariffs. The thinking goes that by slowly ramping up tariffs month by month, this approach would boost negotiating leverage while helping to avoid a spike in inflation. Specifically, one idea involves a schedule of tariffs increasing by about 2-5% a month that would rely on executive authorities under the International Emergency Economic Powers Act. Of note, the plan has not yet been presented to Trump and so anything can still happen.

The dollar weakened on this report but we don’t think it’s a negative. If tariffs are ongoing, then the typical one-shot boost to prices becomes a steady stream of price increases. In other words, inflation. Still, it’s a fool’s errand to try and trade this tariff noise, as a denial will likely be coming soon. Look through the noise and rest assured the dollar rally will continue on the U.S. economic outperformance story alone.

December inflation data will be the highlight. PPI will be reported Tuesday. Headline PPI is expected at 3.5% y/y vs. 3.0% in November while core PPI is expected at 3.8% y/y vs. 3.4% in November. Keep an eye on PPI services ex-trade, transportation, and warehousing, as it feeds into the core PCE calculations. In November, this measure of core services PPI remained at a multi-month high of 4.6% y/y and is consistent with sticky underlying inflation.

New York Fed inflation expectations for December were mixed. 1-year expectations were steady at 3.0%, but 3-year rose four ticks to 3.0% and 5-year fell two ticks to 2.7%. Expectations have been creeping higher in this series and mirrors a similar rise in private sector inflation expectations. Clearly, the Fed won’t be happy that inflation expectations remain stuck near 3%. Schmid and Williams speak today.

NFIB small business optimism jumped again in December. Headline rose to 105.1 vs. 102.1 expected and 101.7 in December and is the highest since October 2018. Seven of the ten sub-indexes rose, including a 16 point jump in firms expecting better business conditions. NFIB Chief Economist Dunkelberg said “Optimism on Main Street continues to grow with the improved economic outlook following the election. Small business owners feel more certain and hopeful about the economic agenda of the new administration.” It was assumed that many businesses held off on hiring last year ahead of the election uncertainty, which suggests that the NFIB readings presage a surge in hiring this year. Stay tuned.

EUROPE/MIDDLE EAST/AFRICA

There are still some hawks at the ECB. GC member Holzmann said “What will happen in two weeks time I don’t know,” he said Tuesday at a conference in Vienna. “I don’t think we can go down as straight as it is, particularly as we recently had some hiccups with regards to inflation. Core inflation still closer to 3% than to 2%. We have a lot of challenges with regard to energy.” Holzmann is speaking to an empty room, as the market is fully pricing in a 25 bp cut January 30. On the other hand, Chief Economist Lane stressed that “We also need to make sure that the economy does not grow too slowly, because then we face a new problem, which is that inflation might stabilize below the target.” Lane speaks again today.

Italy reported December IP. IP rose 0.3% m/m vs. 0.1% expected and a revised 0.1% (was 0.0%) in October, while the y/y rate improved to -1.5% vs. -2.3% expected and a revised -3.5% (was -3.6%) in October. Eurozone reports November IP tomorrow. It is expected at 0.2% m/m vs. 0.0% in October, while the y/y rate is expected at -1.9% vs. -1.2% in October.

The Bank of England continues to face a policy dilemma. Elevated inflation readings argue for cautious easing, but recent economic data have been soft. A 25 bp cut at the next meeting February 6 is quite likely, but then the market is pricing in only one more 25 bp cut after that. With the specter of stagflation still looming, the fiscal outlook remains poor from the combination of higher borrowing costs, falling revenues, and rising outlays. This week’s economic data releases are unlikely to offer the positive surprise necessary to halt the sell-off in GBP and gilts.

ASIA

Bank of Japan Deputy Governor Himino spoke. He noted that “In conducting monetary policy, it is difficult but essential to judge the right timing. The board will have discussion to decide whether to raise the policy rate or not, based on the outlook to be compiled” at the policy meeting this month. He added that “Developments in prices and inflation expectation, including the economic mechanisms behind them, seem to have been largely on the path…If this outlook will continue to be realized, the Bank will raise the policy interest rate accordingly and adjust the degree of monetary easing.” Yes, every meeting is live but with market odds of a hike around 60%, we do not think the BOJ will risk another market meltdown from a hawkish surprise. Odds of a hike rise to 80% in March and fully priced in for May.

Japan reported November current account data. The adjusted surplus came in at JPY3.033 trln vs. JPY2.578 bln expected and JPY2.409 trln in October. However, the investment flows will be of more interest. The November data showed that Japan investors became net buyers of U.S. bonds (JPY993 bln) after one month of net selling. Japan investors stayed net sellers (-JPY267 bln) of Australian bonds for the third straight month and also stayed net sellers of Canadian bonds (-JPY151 bln) for the third straight month. Investors turned net buyers of Italian bonds (JPY248 bln) after one month of net selling. Overall, Japan investors turned total net buyers of foreign bonds (JPY367 bln) after one month of net selling. With the return to net buying, it’s still too early to say that Japan investors have stopped chasing higher yields abroad.

Australia Westpac–Melbourne Institute Consumer Sentiment Index dipped in January. Headline fell - 0.7% to 92.1 vs. 92.8 in December. It was the second straight drop and remains well below the long-term average of 100.5. The details were mixed as current condition sub-indexes declined while the forward-looking ones were flat or increased. The market still sees about 70% odds of a 25 bp cut at the February 18 meeting.

New Zealand Q4 business outlook survey was mixed. A net 26% of firms said their own trading activity deteriorated, suggesting the economy contracted for a third consecutive quarter in Q4. Encouragingly, a net 16% of companies expect the economy to improve in the next 12 months, the first positive reading since mid-2021 and the highest since 2017. The RBNZ has penciled in another 50 bp rate cut to 3.75% in February but warned of slower pace of easing after that, noting it does not forecast to slash the policy rate below neutral (around 3%) throughout 2027.

China reported solid December new loan and money supply data. New loans came in at CNY998nbln vs. CNY779 bln expected and CNY578 bln in November, while aggregate financing came in at CNY2.851 trln vs. CNY2.158 trln expected and CNY2.326 trln in November. For all of 2024, however, new loans of CNY18.09 trln represented the first annual drop since 2011. Similarly, aggregate financing of CNY32.260 trln for all of 2024 was the first annual drop since 2021. Despite stimulus so far, new loan growth continues to slow to all-time lows. More aggressive stimulus is needed, as well as more aggressive structural reforms.

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