Dollar Soft as Major Trade War Avoided

February 04, 2025
  • A major trade war was avoided; China is now in focus as 10% tariffs went into effect; Fed officials remain cautious; JOLTS data will be the highlight; Brazil central bank releases its minutes
  • France Prime Minister Bayrou faces a no confidence vote in parliament; ongoing political paralysis in France and Germany means the ECB will have to do the heavy lifting; UK-EU relations are warming up; Riksbank minutes from the January policy meeting were published
  • BOJ Governor Ueda spoke before parliament

The dollar is off its highs as a major trade war was avoided for now. DXY is trading lower near 108.578 after President Trump delayed tariffs on Mexico and Canada for one month. However, 10% tariffs on China went into effect and led to a round of retaliation from Beijing and so we remain subject to more tariff noise ahead (see below). The yen is softer as haven flows ebb, with USD/JPY trading higher near 155.35. Sterling is trading lower near $1.2415, while the euro is trading lower near $1.0325. Despite the truce, more and more tariff noise is likely in the coming days and weeks. However, we continue to look through that noise 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. Indeed, the tariff noise is keeping the Fed even more cautious (see below). Last week’s G-10 central bank decisions and global Q4 GDP data underscored the U.S. economic exceptionalism that favors the dollar and that should continue this week. Any tariffs would simply turbocharge the move.

AMERICAS

A major trade war was avoided. At least, for now. Both Mexico and Canada have won 30-day reprieves on the planned 25% tariffs. In return, Mexican President Sheinbaum promised to send 10k National Guard officers to the border in an effort to stem the flow of fentanyl and migrants into the U.S. Elsewhere, Canadian Prime Minister Trudeau appointed a new fentanyl czar and will go ahead with a CAD1.3 bln plan to improve border security. As we know by now, U.S. policy can turn on a dime and we await further potential reversals, but for now, markets are breathing a sigh of relief.

China is now in focus as 10% tariffs went into effect today at 1201 AM ET. In retaliation, China slapped a 15% levy on U.S. coal and liquefied natural gas, 10% tariff on U.S. crude oil and agricultural equipment, set export control on tungsten-related material (crucial for weapons and semiconductors), and launched an antitrust probe into Google. President Trump said he plans to speak with China President Xi Jinping “probably over the next 24 hours.” Trump added that “If we can’t make a deal with China, then the tariffs will be very, very substantial.” Our gut feeling is that China won’t give in to such threats as Canada and Mexico did, but at this point, it seems that anything can happen. Stay tuned for more twists and turns.

Fed officials remain cautious. And if nothing else, the ongoing tariff noise will make them even more cautious and should keep the Fed on hold until the eventual tariffs are known. Indeed, Bostic said “I had uncertainty on December 31. The amount of uncertainty that we have today is greater than that,” adding that “Depending on what the data are, it might mean that we are waiting for a while.” Collins said “There’s no urgency for making additional adjustments. The data is going to have to tell us.” Even uber-dove Goolsbee said “Now we’ve got to be a little more careful and more prudent of how fast rates can come down because there are risks that inflation is about to start kicking back up again.” Bostic, Daly, and Jefferson speak today.

JOLTS data will be the highlight. Job openings are expected at 8.000 mln vs. 8.098 mln in November, while the job openings rate is expected to remain steady at 4.8%. if so, this rate would remain well above the 4.5% threshold that typically signals a sharp rise in the unemployment rate. Encouragingly, the ratio of job openings to unemployed stood at 1.1 in November, which is historically strong as that ratio has been above 1 only three times since 1960.

ISM manufacturing PMI for January was very strong. Headline came in at 50.9 vs. 50.0 expected and 49.2 in December and is in expansionary territory for the first time since October 2022. Besides the strong headline, the details were also strong. Employment rose to 50.3 vs. 45.4 in December, while new orders rose to 55.1 vs. 52.1 in December and is the highest since May 2022. Production rose to 52.5 vs. 49.9 in December, while prices paid rose to 54.9 vs. 52.5 in December and is the highest since May 2024. ISM services will be reported tomorrow. Headline is expected to remain steady at 54.0.

Growth remains robust. The Atlanta Fed GDPNow model's estimate for Q1 growth is now 3.9% SAAR vs. 2.9% previously and will be updated tomorrow after the data. The latest Q1 estimate from the NY Fed's Nowcast model stands at 2.9% SAAR and will be updated Friday, while its initial forecast for Q2 growth will come in early March. The economy clearly has strong momentum going into 2025. December factory orders will also be reported today.

Brazil central bank releases its minutes. At last week’s meeting, the bank hiked rates 100 bp to 13.25% and signaled a hike of the same magnitude at the next meeting in March due to rising inflation expectations and a resilient labor market and economy. However, it added that “Beyond the next meeting, the Committee reinforces that the total magnitude of the tightening cycle will be determined by the firm commitment of reaching the inflation target and will depend on the inflation dynamics.” The market is now pricing in another 250 bp of tightening over the next 12 months that would see the policy rate peak near 15.75% vs. 16.25% before the decision.

EUROPE/MIDDLE EAST/AFRICA

France Prime Minister Bayrou faces a no confidence vote in parliament tomorrow after forcing the adoption of a 2025 budget bill. The Socialist leadership said it won’t support the motion, which should keep the government from collapsing. French-German 10-year government bond yield spreads remain contained near recent lows around 75 bp after topping out near 90 bp in December. However, France continues to trade wide of Portugal and Spain and briefly traded wide of Greece back in January. However, France’s fiscal problems have not morphed into a wider eurozone problem.

Ongoing political paralysis in France and Germany means the ECB will have to do the heavy lifting to support the eurozone economy. The market is now pricing in almost 125 bp of total easing over the next 12 months that would see the ECB policy rate bottom at 1.50% vs. 2.00% last week. That means this move lower in the euro still has legs, even more so if the tariffs eventually come. There were no policy-relevant Eurozone economic data releases today.

UK-EU relations are warming up. European Commission President von der Leyen confirmed a joint summit should take place in May. UK Prime Minister Keir Starmer said yesterday he wants a new defense and security pact to be at the heart of a “reset” relationship. Closer UK-EU trade relations can lead to a more favorable UK business investment outlook, which bodes well for GBP.  Our recent piece here about a new UK-EU special partnership is one of our main 2025 macro themes.

Riksbank minutes from the January policy meeting were published. At that meeting, the Riksbank cut rates 25 bp to 2.25%, as expected. The minutes highlight that virtually all executive board members project the policy rate to remain unchanged at 2.25% for the foreseeable future. In contrast, markets are pricing in a lower terminal policy rate of 2.00% over the next 12 months. January CPI data will be reported Thursday and is expected to still show a benign inflation backdrop, which suggests it’s too soon for the Riksbank to pause easing. Bottom line: Fed/Riksbank policy divergence favors a higher USD/SEK.

ASIA

Bank of Japan Governor Ueda spoke before parliament. He said nothing new or surprising as he noted that Japan is in an inflationary environment now rather than deflationary. Ueda added that the BOJ is aiming for “sustainable, stable” 2% inflation. For now, the bank is managing market expectations well, with a modest tightening cycle priced in that has kept USD/JPY relatively stable within the 150-155 range since October. We suspect Japan officials are keeping their heads low and hoping that Japan does not become a focus of Trump tariffs but with the sixth largest trade surplus with the U.S., that seems rather unlikely. Stay tuned.

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