Dollar Soft as Trade War Averted (For Now)

January 27, 2025
  • The U.S. and Colombia stepped back from the brink of a trade war; this week’s G-10 central bank meetings will reassert the monetary policy divergence theme underpinning USD strength; Chicago Fed NAI for December will be the highlight
  • German IFO business climate survey for January was mixed; U.K. BRC reports January shop prices
  • USD/JPY is taking its cue from BOJ expectations; China reported very week official January PMIs; China announced more measures to boost local equity markets; Pakistan cut rates 100 bp to 12.0%, as expected

The dollar remains under pressure after Trump tariff noise over the weekend. DXY is trading lower for the third straight day near 107.067 after Colombia buckled to President Trump’s tariff threats (see below). The yen is outperforming on more hawkish BOJ bets, with USD/JPY trading below 154 for the first time since mid-December (see below). Sterling is trading higher near $1.25 and the euro is trading higher near $1.0510. 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 meetings should underscore monetary policy divergences that favor the dollar (see below).

AMERICAS

The U.S. and Colombia stepped back from the brink of a trade war. Tensions were dialed down late last night as “the Government of Colombia has agreed to all of President Trump’s terms, including the unrestricted acceptance of all illegal aliens from Colombia returned from the United States.” Earlier this weekend, Trump announced travel bans and immediate 25% tariffs on Colombian imports in retaliation for Colombia refusing to accept two U.S. military planes deporting 160 Colombians. Colombia President Petro announced 25% retaliatory tariffs on all U.S. goods but then backed down. The episode highlights how the Trump administration will intertwine trade policy with national security policy and so markets will face greater volatility and surprises. Of note, Mexico also announced over the weekend that it would not allow a U.S. military plane carrying deportees to land. However, the biggest test of this strategy will be with China.

This week’s G-10 central bank meetings will reassert the monetary policy divergence theme underpinning USD strength. The Fed is expected to keep rates steady and to signal no rush to resume easing (Wednesday). The Bank of Canada is expected to cut rates 25b bp to 3.0% following two consecutive 50 bp cuts (Wednesday). The European Central Bank is expected to cut rates 25 bp to 2.75% and stick to its data-dependent guidance (Thursday). Finally, Sweden’s Riksbank is expected to cut rates 25 bp to 2.25%.

Chicago Fed National Activity Index for December will be the highlight. Headline is expected at -0.06 vs. -0.12 in November. If so, the three-month moving average would rise to -0.23 vs. -0.31 in November, the highest since September and further away from the -0.7 threshold that typically signals recession. December new home sales will also be reported and are expected at 2.4% m/m vs. 5.9% in November.

Growth remains robust. The Atlanta Fed GDPNow model is tracking Q4 growth at 3.0% SAAR and will be updated tomorrow. Elsewhere, the New York Fed's Nowcast model is tracking Q4 growth at 2.6% SAAR and Q1 growth at 3.0% SAAR and will be updated Friday. In between, we get our first official read for Q4 GDP Thursday. Consensus sees growth of 2.7% SAAR vs. 3.1% in Q3, driven in large part by strong personal consumption of 3.2% SAAR expected vs. 3.7% in Q3.

Key surveys for January will continue to roll out. Dallas Fed manufacturing will be reported today and is expected at -3.0 vs. 3.4 in December. Dallas Fed services and Richmond Fed manufacturing (-12 expected) and services will be reported tomorrow. Chicago PMI will be reported Friday and is expected at 40.0 vs. 36.9 in December.

EUROPE/MIDDLE EAST/AFRICA

German IFO business climate survey for January was mixed. Headline came in at 85.1 vs. 84.8 expected and 84.7 in December. Current assessment rose to 86.1 vs. 85.4 expected and 85.1 in December, while expectations fell to 84.2 vs. 85.0 expected and 84.4 in December. IFO President Fuest noted that “With Trump increasing uncertainty, with political uncertainty in Germany due to the elections ahead, companies wait before they invest. So it will be another difficult year.” Germany remains the weak link in the eurozone and should keep the ECB is easing mode this week.

U.K. BRC reports January shop prices later today. Shop prices are expected at -0.7% y/y vs. -1.0% in December. If so, it would suggest that official CPI inflation will be favorable. Markets are pricing in a 25 bp cut to 4.5% at the next BOE meeting February 6, as well as 75 bp of total easing over the next 12 months that would see the policy rate bottom near 4.0%.

ASIA

USD/JPY is taking its cue from BOJ interest rate expectations. After last week’s BOJ hike, the market is now pricing in the policy rate to peak near 1.25% over the next three years vs. 1.0% before the decision. The pair is trading below 154 and is the lowest since December 18. It has retraced about half the December-January rally and a break below 152.55 sets up a test of the December 3 low near 148.65. The 200-day moving average near 152.85 may provide some support.

China reported very week official January PMIs. Manufacturing came in at 49.1 vs. expectations it would remain steady at 50.1, while non-manufacturing came in at 50.2 vs. expectations it would remain steady at 52.2. As a result, the composite fell to 50.1 vs.52.2 in December and was the lowest since August. The steady drip feed of stimulus will do little to improve the economy’s medium-term outlook, which we believe hinges crucially on addressing the huge debt overhang. Until that has been accomplished, growth will remain well below expectations and a structural headwind for commodity prices. The Lunar New Year holiday starts tomorrow, and mainland markets will be closed the rest of the week.

China policymakers announced more measures to boost local equity markets, this time by promoting the development of index investment products. Last week, measures were announced to boost local equity investments by mutual funds and state-owned insurance companies. We repeat: While these measures may give local equity markets a temporary boost, they do not address the root causes of China’s malaise, namely a burst property bubble and a huge debt overhang. Until those are addressed, we remain negative on China’s economic outlook and these weak PMI readings confirm our view.

State Bank of Pakistan cut rates 100 bp to 12.0%, as expected. The statement noted that “the Committee viewed that a cautious monetary policy stance is needed to ensure price stability, which is essential for sustainable economic growth. In this regard, the MPC assessed that the real policy rate needs to remain adequately positive on a forward-looking basis to stabilize inflation in the target range of 5-7%.” The bank started the easing cycle with a 150 bp cut to 20.5% back in June 2024. It has cut rates at every meeting since then as inflation has fallen to 4.07% y/y in December, the lowest since April 2018 and down from the 37.97% peak in May 2023. If inflation remains low, further easing is likely this year.

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