Dollar Firm on More Tariff Noise

January 21, 2025
  • Markets have been buffeted by tariff noise; there are two key takeaways from this price action; Canada has made clear it is ready to strike back with retaliatory tariffs; Canada highlight will be December CPI data
  • German ZEW survey for January was mixed; the soggy eurozone growth outlook leaves plenty of room for the ECB to cut rates; U.K. labor market data were mixed
  • The BOJ’s proviso about hiking rates this week seems prescient; Taiwan reported strong December export orders

The dollar Is trading firmer on more tariff noise. CAD and MXN are underperforming after reports that the U.S. will slap 25% tariffs on Mexico and Canada by February 1, offsetting earlier reports that tariffs on China would be delayed (see below). USD/JPY is trading higher near 155.90 after trading below 155 earlier. Sterling is trading lower near $1.2235 after mixed labor market data (see below), while the euro is trading lower near $1.0350 after a mixed German ZEW survey (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.

AMERICAS

Markets were greeted yesterday with reports that incoming President Trump would not unveil aggressive China-specific tariffs on Day One. Instead, reports suggest Trump is eager to take a more negotiated approach with China’s President Xi. In that regard, the U.S. will first conduct studies on the state of Trump’s Phase One trade agreement and “China’s adherence to this agreement will now be assessed, to determine whether enforcement or changes are required.”

On the other hand, reports emerged late yesterday that Trump will impose tariffs of as much as 25% on goods coming from Mexico and Canada by February 1. Trump cited flows of undocumented immigrants and drugs as the reasons behind the tariffs. These tariffs would likely have a significant impact on the U.S., as Mexico is now our number one trading partner and Canada number two, as recent shifts in trade patterns have pushed China down from number one to number three. Lastly, Trump said that he was still considering a universal tariff on all imported goods into the U.S.

There are two key takeaways from this price action. The first is that the markets will continue to trade at the whims of Trump’s unpredictable trade policies. The second key takeaway is that the strong dollar narrative remains unchanged. We continue to look through all this tariff noise and believe that whatever final tariff plan eventually emerges, it will only magnify the current drivers of the ongoing dollar rally. Simply put, U.S. economic exceptionalism has been and always will be the major driver behind the strong dollar.

The Fed media blackout is in place until Chair Powell’s post-decision press conference January 29. Despite some mixed signals from officials last week, the market sees the next and only rate cut coming in July. Of course, it will all depend on the data but given the strong momentum in the economy, we agree with the market see steady rates in H1.

Regional Fed surveys for January will continue to roll out. Philly Fed non-manufacturing will be reported today and stood at -3.4 in December. Kansas City Fed manufacturing will be reported Thursday. Kansas City Fed services will be reported Friday.

Canada’s government has made clear it is ready to strike back with retaliatory tariffs if the U.S. moves ahead with its tariff plans. Finance Minister LeBlanc warned “We have spent the last number of weeks preparing potential response scenarios for the government of Canada, in partnership with provinces and Canadian business leaders and union leaders.” An all-out trade war between Canada and the U.S. will be a significant drag on Canada’s economy and lead to further weakness in CAD. Canada’s exports to the US make up more than 20% of its GDP. Stay tuned.

Canada highlight will be December CPI data. Headline is expected to fall tick to 1.8% y/y, while core trim is expected to fall two ticks to 2.4% y/y and core median is expected to fall two ticks to 2.5 y/y. The Bank of Canada projects headline and core (the average of core trim and median) inflation to average 2.1% and 2.3% over Q4, respectively. The bank has room to ease further, though at a more gradual pace because inflation is stabilizing around 2%. Indeed, Governor Macklem effectively ruled out additional jumbo cuts, pointing out that officials will consider further rate cuts but likely at a slower pace. The market sees nearly 80% odds of a 25 bp cut at the January 29 meeting.

The Bank of Canada’s Q4 Business Outlook Survey validates the case for a more gradual pace of easing. The so-called BOS indicator improved to -1.2 (the highest since Q1 2023) vs. -2.29 in Q3 as firms expect sales activity to pick up and cost growth to ease over the next 12 months. Further rate cuts were also a source of optimism. Still, the BOS indicator remains below average and is consistent with an unimpressive growth outlook. Bottom line: Fed/BOC policy trend continues to support the uptrend in USD/CAD. The BOC has room to keep easing to prevent a sharper slowdown in Canadian economic activity. The market continues to see about 75% odds of a 25 bp cut to 3.0% at the January 29 policy-setting meeting.

EUROPE/MIDDLE EAST/AFRICA

German ZEW survey for January was mixed. Expectations fell to 10.3 vs. 15.1 expected and 15.7 in December, while expectations rose to -90.4 vs. expectations it would remain steady at -93.1. Germany remains the weak link in the eurozone, contracting in both 2023 and 2024 and showing little signs of life so far in 2025.

The soggy eurozone growth outlook leaves plenty of room for the ECB to cut rates. It is widely expected to bring down the policy rate towards the lower end of its neutral range, estimated at around 1.5-3.0%. Indeed, Governing Council member Kazimir noted that the bank’s intention is to cut rates to neutral, which is “probably closer to 2% than to 3%.” Kazimir added that a rate cut next week is a done deal while “three or four cuts in a row are feasible.” Markets are pricing in 100 bp of total easing over next 12 months that would see the policy rate bottom near 2.0%.

U.K. labor market data were mixed. The number of employees on payrolls dropped by -47k in December after a revised decline of -32k (was -35k) the previous month. The unemployment rate rose one tick to 4.4% in the three months ending in November vs. Bank of England Q4 projection of 4.2%. However, wage growth quickened more than expected. Total average weekly earnings ex-bonuses for the three months ending in November rose 5.6% y/y vs. 5.5% expected and 5.2% previously. The policy-relevant private sector earnings ex.-bonuses surged to near a one year high of 6.0% y/y vs. 5.4% previously and is tracking well above the Bank of England’s (BOE) Q4 projection of 5.1% y/y. Faster wage growth underpins consumer spending activity but also risks feeding into directly inflation, which reduces the risks the BOE eases more aggressively. Bottom line: ECB/BOE policy trend favors a lower EUR/GBP.

ASIA

The Bank of Japan’s proviso about hiking rates this week seems prescient. Recall reports last week of unnamed BOJ officials saying that the only caveat was a potential policy surprise from Trump ahead of the decision, as inflation and wages were in line with the bank’s efforts to meet the 2% target. Trump has certainly offered some surprises this week that have fed into increased market volatility. However, we do not think the surprises have been enough to change the BOJ’s thinking yet. The odds of a 25 bp hike this Friday stands at nearly 90%.

Taiwan reported strong December export orders. Orders came in at 20.8% y/y vs. 18.8% expected and 3.3% in November. This was the strongest since February 2022 but due largely to low base effects. Q4 GDP data will be reported Friday. Growth is expected at 2.0% y/y vs. 4.17% in Q3. If so, it would be the slowest since Q3 2023. Regional growth and activity remains at risk from slow mainland growth. As such, we believe low price pressures will allow Taiwan’s central bank to cut rates this year if the economy slows too much.

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