Dollar Firm as Trade War Looms

January 31, 2025
  • Tariffs are coming over the weekend; the Fed media blackout has ended; December PCE data will be the highlight; personal income and spending will be reported at the same time; Q4 ECI will also be important; Canada highlight will be November GDP; Colombia is expected to cut rates 25 bp to 9.25%; Peru reports January CPI data Saturday
  • ECB delivered the widely expected 25 bp cut; Lagarde did not offer much policy guidance; eurozone CPI data for January continue rolling out; ECB consumer inflation expectations survey was mixed; eurozone consumption data have been mixed; U.K. Lloyds business barometer was mixed in January
  • January Tokyo CPI ran hot; BOJ Governor Ueda stuck to the bank’s guidance; Japan labor market and real sector data were better than expected; January ANZ New Zealand consumer confidence was disappointing; Korea reports January trade data Saturday

The dollar is firm ahead of weekend tariffs. DXY is trading higher near 108.304 after President Trump reiterated his threat to impose 25% tariffs on Canada and Mexico tomorrow (see below). USD/JPY is trading higher near 154.80 despite Tokyo inflation running hot (see below). Sterling is trading lower near $1.2410 and the euro is trading lower near $1.0375 as market pricing shifts to a more dovish ECB after yesterday’s 25 bp cut (see below). More and 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 G-10 central bank decisions and global Q4 GDP data underscore the U.S. economic exceptionalism that favors the dollar.

AMERICAS

Tariffs are coming over the weekend. Late yesterday, President Trump vowed to go through with his threats to slap Canada and Mexico with 25% tariffs tomorrow, February 1. He said “We’ll be announcing the tariffs on Canada and Mexico for a number of reasons. Number one is the people that have poured into our country so horribly and so much. Number two are the drugs, fentanyl and everything else that have come into the country. Number three are the massive subsidies that we’re giving to Canada and to Mexico in the form of deficits.” We suspect these two countries will not roll over like Colombia did and we see a real threat of retaliation. Stay tuned.

Fed officials will start giving their own takes on the recent decision to hold. Governor Bowman speaks today. As the lone dissent at the November meeting in favor of a hold, she will likely sound hawkish tone. We continue to take issue with Powell’s suggestion that the change in the Fed statement on inflation was not meant to send any signal and that the Fed “just chose” to shorten it. We find this incredibly hard to believe given that the Fed knows full well that the market is hanging on its every phrase and wording. Quite frankly, Powell should not have downplayed this change because inflation is in fact no longer making any progress towards the 2% target. We suspect the hawks are just as unhappy as we are with Powell’s characterization and will make it known. Perhaps Bowman will be the first.

December PCE data will be the highlight. Headline is expected to pick up two ticks to 2.6% y/y while core is expected to remain steady at 2.8% y/y. Of note, the Cleveland Fed’s inflation Nowcast model estimates headline and core PCE at 2.6% and 2.8%, respectively. For January, the model estimates 2.4% and 2.6%, respectively. The already released December CPI data continue to show that progress on inflation is stalling well above 2%, which supports the case for a shallow Fed easing cycle.

Personal income and spending will be reported at the same time. Income is expected at 0.4% m/m vs. 0.3% in November, spending is expected at 0.5% m/m vs. 0.4% in November, and real spending is expected to remain steady at 0.3% m/m. As long as jobs are being created, spending will be well-supported.

We got our first official read for Q4 GDP. Growth came in at 2.3% SAAR vs. 2.6% expected and 3.1% in Q3, driven in large part by strong personal consumption of 4.2% SAAR vs. 3.2% expected and 3.7% in Q3. Personal consumption contributed 2.82 ppt to headline growth, government consumption contributed 0.42 ppt, and net exports were almost neutral at 0.04 ppt. Inventories were the greatest drag, subtracting -0.93 ppt from headline growth, while fixed investment subtracted -0.10. Lastly, private domestic demand rose a still-strong 3.2% SAAR.

Growth remains robust in 2025. The New York Fed's Nowcast model is tracking Q1 growth at 3.0% SAAR and will be updated today. Its initial estimate for Q2 growth will come in early March. Elsewhere, the Atlanta Fed GDPNow model will release its initial estimate for Q1 growth today.

Q4 employment cost index will also be important. ECI is expected to rise 0.9% q/q vs. 0.8% in Q3. This is the Fed’s favorite wage data because it’s more comprehensive and controls for changes in the composition of employment. On a y/y basis, ECI wages and salaries eased from a high of 5.3% in Q2 2022 to 3.9% in Q3 2024. Average hourly earnings and the Atlanta Fed wage growth tracker points to ECI wages and salaries y/y growth between 3.9-4.2%. This would be consistent with the Fed’s 2% inflation stability goal as productivity growth is around 2%.

Chicago PMI will be reported. Headline is expected at 40.0 vs. 36.9 in December. S&P Global preliminary PMIs for January have already been reported as weaker, while ISM PMIs will be reported next week. The Chicago PMI has not correlated very well with the national readings for the past couple of years and so offers very little insight.

Canada highlight will be November GDP data. Statistics Canada advance information indicates that real GDP fell -0.1% m/m after rising 0.3% in October. Of note, the y/y rate is expected to slow to 1.6% vs. 1.9% in October. The December real GDP estimate will be published at the same time. The Bank of Canada warned that a long-lasting and broad-based trade conflict would badly hurt economic activity in Canada and would put direct upward pressure on inflation. This complicates the BOC’s job, as monetary policy cannot lean against weaker output and higher inflation at the same time. The risk of all-out trade war between Canada and the U.S. could trigger a more pronounced USD/CAD overshoot.

Colombia central bank is expected to cut rates 25 bp to 9.25%. However, a quarter of the 32 analysts polled by Bloomberg look for steady rates. At the last meeting December 20, the bank delivered a hawkish surprise and cut rates 25 bp to 9.5% vs. 50 bp expected. The vote was 5-2, with one dissent in favor of a 50 bp move and another one in favor of a 75 bp move. Governor Villar said the weak peso and hawkish Fed guidance were behind the “prudent” cut. With the peso gaining over 5% vs. the dollar since that meeting, a 25 bp seems likely today. The swaps market is pricing in 150 bp of total easing over the next 12 months that would see the policy rate bottom near 8.0%.

Peru reports January CPI data Saturday. Headline is expected at 2.05% y/y vs. 1.97% in December. At the last meeting January 9, the central bank cut rates 25 bp to 4.75%, as expected. Since October, the bank has been cutting every other meeting as it maintains a cautious pace due to sticky core inflation. If it sticks to this pattern, it should remain on hold at the next meeting February 13. However, this will depend in part on core inflation moving closer to 2% in the coming months.

EUROPE/MIDDLE EAST/AFRICA

European Central Bank delivered the widely expected 25 bp cut. The bank reiterated that it “is not pre-committing to a particular rate path” and “the disinflation process is well on track.” There were no new macroeconomic projections at this meeting as the next updates will be published at the March meeting. Of note, markets are now pricing in another 100 bp of easing over the next 12 months that would see the policy rate bottom near 1.75% vs. 2.00% at the start of this week.

President Lagarde did not offer much policy guidance. Lagarde confirmed that the decision to ease was unanimous. She also pointed out that the conditions for a recovery remain in place, underpinned in part by a robust labor market and higher real incomes. Still, she cautioned that the risks to economic growth remain tilted to the downside. Moreover, Lagarde stressed there were no discussions about where to stop cutting rates and no debate “at all” about cutting rates 50 bp. Lagarde did flag that ECB staff will publish an update on the neutral rate on February 7. The ECB’s current neutral range estimate is between 1.5-3.0%.

Eurozone CPI data for January continue rolling out. France’s EU Harmonised inflation came in a tick lower than expected and was steady at 1.8% y/y. Germany reports later today is expected to remain steady at 2.8% y/y. Yesterday, Spain’s EU Harmonised inflation came in a tick higher than expected at 2.9% y/y vs. 2.8% in December. Italy and the eurozone report Monday. Eurozone headline is expected to remain steady at 2.4% y/y while core is expected to fall a tick to 2.6% y/y.

ECB December consumer inflation expectations survey was mixed. 1-year expectations rose two ticks to 2.8% vs. 2.7% expected while 3-year expectations remained steady as expected at 2.4% for a second straight month. With longer-term inflation expectations still well anchored around 2%, the ECB has scope to ease further to support the Eurozone sluggish growth outlook.

Eurozone consumption data for December have been mixed. German retail sales came in at 1.1% y/y vs. 2.6% expected and a revised 3.1% (was 2.1%) in November, while Spanish retail sales came in at 4.0% y/y vs. 2.0% expected and a revised 0.9% (was 1.0%) in November. Yesterday, France reported consumer spending at 0.9% y/y vs. 0.2% expected and a revised 0.2% (was 0.3%) in November. Italy reports retail sales next Wednesday and eurozone reports next Thursday.

U.K. Lloyds business barometer was mixed in January. The headline index fell to a 13-month low of 37 vs. 39 in December, suggesting business investment backdrop remains sluggish. However, the 12-month ahead business activity index improved to 51 vs. 47 in December and price expectations fell to 59 and were the lowest since August. The Bank of England is widely expected to cut rates 25 bp to 4.50% next Thursday. Most indicators of near-term activity have weakened, and services inflation cooled more than the BOE anticipated in December.

ASIA

January Tokyo CPI ran hot. Headline came in at 3.4% y/y vs. 3.0% expected and a revised 3.1% (was 3.0%) in December, core (ex-fresh food) picked up a tick as expected at 2.5% y/y, and core ex-energy picked up a tick as expected to 1.9% y/y. Headline is the highest since April 2023 while core is the highest since February 2024. Both suggest upside risks to the national reading.

Bank of Japan Governor Ueda stuck to the bank’s guidance. Ueda noted that more hikes are in the pipeline if its economic and price outlooks are realized. However, he cautioned that monetary policy will remain accommodative to support ongoing price trends. The comments suggest the BOJ policy rate will likely peak around 1.00% over the next two years, in line with market pricing. This seems about right as the BOJ expects inflation to stabilize around its 2% target in 2026. Bottom line: the BOJ shallow policy normalization cycle remains an ongoing headwind for JPY.

December labor market and real sector data were slightly better than expected. The unemployment rate fell a tick to 2.4% vs. steady expected and the job-to-applicant ratio remained steady as expected at 1.25. Retail sales came in at 3.7% y/y vs. 3.2% expected and 2.8% in November, IP came in at -1.1% y/y vs. -2.2% expected and -2.7% in November, and housing starts came in at -2.5% y/y vs. -3.9% expected and -1.8% in November. Household spending will be reported next Friday and is expected at 0.3% y/y vs. -0.4% in November.

January ANZ New Zealand consumer confidence was disappointing. Headline fell to 96.0 vs. 100.2 in December and remains below long-run average of 113.7. Additionally, the proportion of households thinking it’s a good time to buy a major household item, the best retail indicator, dropped a sharp 15 points to -16. In line with RBNZ guidance, markets continue to price in another 50 bp cut to 3.75% at the February 19 meeting and the policy rate to bottom at 3.00% over the next 12 months.

Korea reports January trade data Saturday. Exports are expected at -14.0% y/y vs. 6.6% in December, while imports are expected at -10.6% y/y vs. 3.3% in December. The expected drop in exports is due to high base effects from last year, but the expected drop in imports is strange as base effects from last year are low. Risks to regional trade and activity remain skewed to the downside.

Brown Brothers Harriman & Co. (“BBH”) may be used as a generic term to reference the company as a whole and/or its various subsidiaries generally. This material and any products or services may be issued or provided in multiple jurisdictions by duly authorized and regulated subsidiaries.This material is for general information and reference purposes only and does not constitute legal, tax or investment advice and is not intended as an offer to sell, or a solicitation to buy securities, services or investment products. Any reference to tax matters is not intended to be used, and may not be used, for purposes of avoiding penalties under the U.S. Internal Revenue Code, or other applicable tax regimes, or for promotion, marketing or recommendation to third parties. All information has been obtained from sources believed to be reliable, but accuracy is not guaranteed, and reliance should not be placed on the information presented. This material may not be reproduced, copied or transmitted, or any of the content disclosed to third parties, without the permission of BBH. All trademarks and service marks included are the property of BBH or their respective owners.© Brown Brothers Harriman & Co. 2024. All rights reserved.

As of June 15, 2022 Internet Explorer 11 is not supported by BBH.com.

Important Information for Non-U.S. Residents

You are required to read the following important information, which, in conjunction with the Terms and Conditions, governs your use of this website. Your use of this website and its contents constitute your acceptance of this information and those Terms and Conditions. If you do not agree with this information and the Terms and Conditions, you should immediately cease use of this website. The contents of this website have not been prepared for the benefit of investors outside of the United States. This website is not intended as a solicitation of the purchase or sale of any security or other financial instrument or any investment management services for any investor who resides in a jurisdiction other than the United States1. As a general matter, Brown Brothers Harriman & Co. and its subsidiaries (“BBH”) is not licensed or registered to solicit prospective investors and offer investment advisory services in jurisdictions outside of the United States. The information on this website is not intended to be distributed to, directed at or used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Persons in respect of whom such prohibitions apply must not access the website.  Under certain circumstances, BBH may provide services to investors located outside of the United States in accordance with applicable law. The conditions under which such services may be provided will be analyzed on a case-by-case basis by BBH. BBH will only accept investors from such jurisdictions or countries where it has made a determination that such an arrangement or relationship is permissible under the laws of that jurisdiction or country. The existence of this website is not intended to be a substitute for the type of analysis described above and is not intended as a solicitation of or recommendation to any prospective investor, including those located outside of the United States. Certain BBH products or services may not be available in certain jurisdictions. By choosing to access this website from any location other than the United States, you accept full responsibility for compliance with all local laws. The website contains content that has been obtained from sources that BBH believes to be reliable as of the date presented; however, BBH cannot guarantee the accuracy of such content, assure its completeness, or warrant that such information will not be changed. The content contained herein is current as of the date of issuance and is subject to change without notice. The website’s content does not constitute investment advice and should not be used as the basis for any investment decision. There is no guarantee that any investment objectives, expectations, targets described in this website or the  performance or profitability of any investment will be achieved. You understand that investing in securities and other financial instruments involves risks that may affect the value of the securities and may result in losses, including the potential loss of the principal invested, and you assume and are able to bear all such risks.  In no event shall BBH or any other affiliated party be liable for any direct, incidental, special, consequential, indirect, lost profits, loss of business or data, or punitive damages arising out of your use of this website. By clicking accept, you confirm that you accept  to the above Important Information along with Terms and Conditions.

 
1BBH sponsors UCITS Funds registered in Luxembourg, in certain jurisdictions. For information on those funds, please see bbhluxembourgfunds.com



captcha image

Type in the word seen on the picture

I am a current investor in another jurisdiction