Dollar Hit by Reports of Limited Trump Tariff Plans

January 06, 2025

Win Thin

This will be a big week for markets; reports of a more limited tariff approach under Trump has hit the dollar; U.S. yields continue to climb at the long end ahead of a heavy auction week; Fed officials remain cautious; final S&P Global services and composite PMIs will be reported today; Canada highlight will be December PMIs; Chile central bank releases its minutes
France appears to be charting a more conservative path to reducing the budget deficit; eurozone December CPI readings will continue to roll out; eurozone and U.K. reported final December services and composite PMIs; U.K. BRC reports key December data; Israel is expected to keep rates steady at 4.5%
BOJ Governor Ueda spoke; Japan reported soft final December PMIs; Australia reported firm final December PMIs; Caixin reported mixed December services and composite PMIs

The dollar is under pressure at the start of a big data week. DXY is trading lower for the second straight day near 107.94 after trading at a new cycle high near 109.533 Thursday. The euro is trading higher near $1.0415 after trading at a new cycle low Thursday near $1.0225, while sterling is trading higher near $1.2535 after trading as low as $1.2355 Thursday. USD/JPY trading lower near 157.30 as Japan returned from holiday. The knee-jerk reaction to reports of a more limited tariff plan has been to sell the dollar. We look through this and believe dollar dominance to continue in 2025 due to the ongoing economic and monetary policy divergence themes. Simply put, the strong U.S. fundamental story of strong growth, elevated inflation, and a more hawkish Fed continues to favor higher UST yields and a higher dollar, regardless of the tariffs.

AMERICAS

This will be a big week for markets. The Fed left a hawkish message for the markets last month and so the next cut isn’t fully priced in until the June FOMC meeting. Of course, its decisions remain data-dependent and so key jobs and CPI data will be closely watched each and every month. We get a slew of important December data points this week that will help set the tone for Q1 trading, culminating in the December jobs report Friday. As it is, the dollar has started off this year strong and so this week’s data will be key for sustaining that surge.

Reports of a more limited tariff approach under Trump has hit the dollar. Washington Post is reporting that the incoming administration will consider tariffs on every country but may only target critical imports. This is a much more limited approach than the universal tariffs that Trump touted on the campaign trail. This is likely a trial balloon and the story is still developing so stay tuned. That said, U.S. economic outperformance should continue to drive the dollar higher regardless of the tariffs.

U.S. yields continue to climb at the long end ahead of a heavy auction week. The 30-year yield traded at the highest level since November 2023 near 4.85% today, while the 10-year yield is lagging and has yet to break above the late December high near 4.64%. Treasury has a heavy auction schedule this week, with $58 bln of 3-year notes to be sold today, $39 bln of 10-year notes to be sold tomorrow, and $22 bln of 30-year bonds to be sold Wednesday. For now, higher yields should help keep demand for U.S. assets strong.

Fed officials remain cautious. Over the weekend, San Francisco Fed President Daly noted that inflation remains “uncomfortably above our target.” Fed Governor Kugler said that “Obviously our job is not done. We’re not at 2% yet, so we’re definitely aiming still to get there, and we know the job is not done.” We believe this is now Fed consensus. Of note, Daly became a non-voter this year. Governor Cook speaks today.

Final S&P Global services and composite PMIs will be reported today. The preliminary readings came in at 58.5 and 56.6, respectively, and both are at cycle highs. December ISM services PMI will be reported tomorrow. Headline is expected at 53.5 vs. 52.1 in November. Keep an eye on prices paid, which is expected at 57.1 vs. 58.2 in November. Last week, ISM manufacturing PMI came in 49.3 vs. 48.2 expected and 48.4 in November. Of note, prices paid there came in at 52.5 vs. 51.8 expected and 50.3 in November.

Growth remains solid. The Atlanta Fed GDPNow model is tracking Q4 growth at 2.4% SAAR and will be updated tomorrow after the data. Elsewhere, the New York Fed's Nowcast model is tracking Q4 growth at 1.9% SAAR and Q1 growth at 2.2% SAAR and will be updated Friday.

Canada highlight will be December PMIs. S&P Global services and composite PMIs will be reported today. Ivey PMI will be reported tomorrow. Last week, S&P Global manufacturing PMI rose two ticks to 52.2. The Bank of Canada shifted to a less dovish stance at the December 11 meeting and the market is pricing in only 75 bp of further easing over the next 12 months.

Chile central bank releases its minutes. At that December 17 meeting, the central bank cut rates 25 bp to 5.0% and signaled a new phase as Governor Costa noted that inflation will be around 5% in early 2025, a level that she called “uncomfortable” even as she stressed that “From here on, it shouldn’t be surprising that we enter a stage in which there are pauses.” December CPI data will be reported Wednesday and headline is expected at 4.7% y/y vs. 4.2% in November. If so, it would reverse the November drop and move further above the 2-4% target range. No wonder the swaps market is no longer pricing in any further easing for this cycle.

EUROPE/MIDDLE EAST/AFRICA

France appears to be charting a more conservative path to reducing the budget deficit. With regards to previous plans to tackle the deficit to GDP ratio estimated at around 6.1% in 2024, new Finance Minister Lombard noted that “If we target 5%, it’s more than a 1% gap - which is considerable - and I think too much as we also need to support the economy. So we are targeting a deficit that would be between 5% and 5.5%.” Lombard has to make these concessions in order to get enough support in the bitterly divided National Assembly. Indeed, Lombard added that “I want to reach at least a non-censure agreement for our country to have a budget as soon as possible.” French 10-year bonds are still trading wide of Greece and so the market remains skeptical. Stay tuned.

Eurozone December CPI readings will continue to roll out. Germany reports later today and its EU Harmonised inflation is expected to accelerate two ticks to 2.6% y/y. France and Italy report tomorrow. France’s EU Harmonised inflation is expected to accelerate two ticks to 1.9% y/y while Italy’s is expected to accelerate a tick to 1.6% y/y. Last week, Spain’s readings ran hot as its EU Harmonised inflation accelerated four ticks to 2.8% y/y and its core reading accelerated two ticks to 2.6% y/y. Eurozone also reports CPI tomorrow. Headline is expected to accelerate two ticks to 2.4% y/y and core is expected to remain steady at 2.7% y/y. Still, the overall disinflation process should continue and keep the ECB in easing mode. The market is pricing in only 100 bp of further easing in this cycle but we suspect it will have to cut more.

Final December services and composite PMIs were reported. Headline services rose two ticks from the preliminary to 51.6, which pushed the headline composite up a tick to 49.6. Looking at the country breakdown, the German composite rose two ticks from the preliminary to 48.0 while France rose nearly a point to 47.5. Italy and Spain reported for the first time and their composite PMIs came in at 49.7 and 56.8, respectively, as both improved significantly from November.

U.K. final December services and composite PMIs were reported. Services fell three ticks from the preliminary to 51.1, which helped dragged the composite down a tick to 50.4. The composite PMI has fallen four straight months to the lowest since October 2023 and suggests that the economy continues to slow under the weight of tight monetary policy. S&P Global economist noted that “Concerns about the impact of rising payroll costs, alongside a general unease about the climate for business investment, were reported as the main factors weighing on prospects for growth in 2025.” More worrisome, the PMI survey showed that firms reduced headcount at the fastest pace in more than 15 years (excluding the pandemic) after Chancellor Reeves hiked payroll taxes in her October budget. Nearly 25% of employers said they’d reduced headcount as a result.

U.K. BRC reports key December data. Like-for-like sales will be reported later today and are expected at -0.2% y/y vs. -3.4% in November. Shop prices will be reported Wednesday and are expected at -0.4% y/y vs. -0.6% in November. Both should provide some insight into the official retail sales and CPI data out later this month.

Bank of Israel is expected to keep rates steady at 4.5%. At the last meeting November 25, the bank kept rates steady whilst noting that “There are several risks of a possible acceleration of inflation: geopolitical developments and their impact on economic activity, prolonged supply limitations, volatility of the shekel, and fiscal developments.” The swaps market is pricing in steady rates over the next three months followed by 25 bp of easing over the subsequent three months.

ASIA

Bank of Japan Governor Ueda spoke. Appearing before the Japanese Bankers Association, Ueda noted that “Our stance is that we will raise the policy interest rate to adjust the degree of monetary easing if economic and price conditions keep improving.” Of course, this is really nothing new but is a reminder that the bank plans to tighten policy further. When is the big question. Markets see 45% odds of a hike in January, rising to 75% in March and fully priced in for May. With the Fed not expected to cut again until June, that means relative monetary policy divergences will continue to favor the dollar.

Japan reported soft final December PMIs. Services fell half a point from the preliminary to 50.9, which dragged the composite down three ticks from the preliminary to 50.5. Still, the composite has remained above 50 for two straight months.

Australia reported firm final December PMIs. Services rose four ticks from the preliminary to 50.8, which pulled the composite up three ticks from the preliminary to 50.2. This means the composite has remained above 50 for three straight months, albeit barely. With China’s outlook still quite poor, we expect the composite to move back below 50 in the coming months.

Caixin reported mixed December services and composite PMIs. Services came in at 52.2 vs. 51.4 expected and 51.5 in November. However, because its manufacturing PMI fell a full point to 50.5, the composite PMI fell to 51.4 vs. 52.3 in November and was the lowest since September. This contrasts with the official composite PMI, which rose to 52.2 vs. 50.8 in November and was the highest since March.

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