Game On

January 31, 2025
6 min read

Game On

  • President Trump set to go forward with 25% tariffs on Canada and Mexico starting Saturday.
  • US economy is in a good place and inflation is stalling above 2%. Fed is in no rush to resume easing.
  • Eurozone faces additional headwinds. ECB has scope to ease further.

USD retraced some of its overnight gains triggered by US President Donald Trump’s tariff threat. Trump confirmed the US will impose 25% tariffs on imports from Canada and Mexico starting Saturday. Unsurprisingly, CAD and MXN were the biggest losers on the news.

Regardless, the fundamental USD uptrend is intact. US economic outperformance continues to support monetary policy divergence between the Fed and other major central banks. In fact, 2-year Treasury yields widened versus comparable G10 government bond yields.

The US economy is in a good place despite slower than expected growth in Q4. Real GDP increased 2.3% SAAR (consensus: 2.6%) vs. 3.1% in Q3 but under the hood economic activity is solid. Personal consumption spending was the biggest growth tailwind rising 4.2% SAAR vs. 3.7% in Q3 and contributing 2.82pts to Q4 GDP. Government spending and net exports added 0.42pts and 0.04pts to Q4 GDP, respectively. Private investment was the main drag, subtracting -1.03pts from Q4 GDP largely due to inventory destocking. Excluding the volatile inventory item, real final sales to private domestic purchaser rose 3.2% SAAR vs. 3.4% in Q3 which is consistent with robust domestic demand.

Today, the US December PCE data is expected to show that progress on inflation is stalling well above 2% (1:30pm London). Headline PCE is expected at 2.6% y/y vs. 2.4% in November and core PCE is projected at 2.8% y/y vs. 2.8% in November. For comparison, the already released December CPI data showed headline CPI up two ticks to 2.9% y/y and core CPI ex. food & energy down one tick to 3.2% y/y.

Meanwhile, US December personal income and spending should validate the strong domestic demand backdrop highlighted in the Q4 GDP print. Personal income is projected at 0.4% m/m vs. 0.3% in November, personal spending is expected at 0.5% m/m vs. 0.4% in November, and real personal spending is forecast at 0.3% m/m vs. 0.3% in November.

The US Q4 employment cost index (ECI) is the other noteworthy data on the docket today (1:30pm London). The ECI is the Fed’s favorite wage data because it’s more comprehensive and controls for changes in the composition of employment. ECI is expected to rise 0.9% q/q vs 0.8% in Q3. On an annual basis, ECI wages & salaries eased from a high of 5.3% in Q2 2022 to 3.9% in Q3. Average hourly earnings and the Atlanta Fed wage growth tracker points to ECI wages & salaries annual growth between 3.9% and 4.2%. This would be consistent with the Fed’s 2% inflation stability goal as productivity growth is around 2%.

Fed Governor Michelle Bowman gives brief remarks on the economy (1:30pm London). A text of her speech will be released but there is no Q&A session. Bowman will likely stick to the Fed’s script that it’s in no rush to resume easing.

EUR/USD is consolidating around 1.0400. As was widely expected, the ECB cut the policy rate 25bps to 2.75% yesterday. The ECB reiterated that it “is not pre-committing to a particular rate path” and “the disinflation process is well on track.”

ECB President Christine Lagarde did not offer much policy guidance. Lagarde confirmed that the decision to ease yesterday was unanimous. Lagarde 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, Lagarde cautioned that the risks to economic growth remain tilted to the downside and the economy is still facing headwinds.

Moreover, Lagarde stressed there were no discussions about where to stop cutting rates and unlike in December, there was no debate “at all” about slashing rates 50bps. Lagarde did flag that ECB staff will publish an updated on the neutral rate next Friday. This could pave the way for the ECB to drop description that monetary policy remains restrictive. The ECB’s current neutral range estimate is between 1.50% and 3.00%.

Eurozone interest rate futures adjusted lower yesterday and price-in decent odds the ECB policy rate throughs at 1.75% vs. 2.00% before the Eurozone GDP data/ECB rate decision. Indeed, with the Eurozone economy stagnating in Q4, the ECB has room to cut rates further. In contrast, the US economy grew 0.6% q/q in Q4 and US interest rate futures continues to price-in the Fed funds rate to hit a floor at around 4.00% in the next 12 months. Bottom line: ECB/Fed policy trend remains a drag for EUR/USD.

The ECB December consumer inflation expectations survey is up next (9:00am London). 1-year expectations is forecast to rise one tick to 2.7% while 3-year expectations is projected to remain at 2.4% for a second consecutive month.

Germany January EU harmonized CPI data is also due today (1:00pm London) and will offer a preview for next week’s Eurozone January CPI print. For reference, France’s EU harmonized CPI was lower than anticipated at 1.8% y/y (consensus: 1.9%) vs. 1.8% in December while Spain’s EU harmonized CPI was higher than anticipated at 2.9% y/y (consensus: 2.8%) vs. 2.8% in December.

GBP/USD is range-bound around 1.2450. The UK January Lloyds business barometer was mixed. The headline index fell to a 13-month low at 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. The Bank of England (BOE) is widely expected to slash the policy rate 25bps to 4.50% next Thursday. Most indicators of UK near-term activity have declined, and services inflation cooled more than the BOE anticipated in December.

USD/JPY is holding above technical support at 154.00. Bank of Japan (BOJ) Governor Ueda stuck to the bank’s guidance. Ueda noted that more hikes are in the pipeline if the economic and price outlooks are realized but cautioned that monetary policy will remain accommodative to support price trend. 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 is an ongoing headwind for JPY.

USD/CAD pulled back to 1.4450 after a kneejerk uptick near 1.4600 yesterday. Canada’s November GDP is the domestic focus (1:30pm London). Statistics Canada advance information indicates that real GDP decreased -0.1% m/m after rising 0.3% in October. The December real GDP estimate will be published at the same time.

The Bank of Canada (BOC) warned that a long-lasting and broad-based trade conflict would badly hurt economic activity in Canada and 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 US can trigger a more pronounced USD/CAD overshoot.

NZD/USD is firmer but the prospect for more RBNZ rate cuts can further weigh on NZD. New Zealand January ANZ consumer confidence was disappointing. Consumer confidence dipped 4 points to a three-month low at 96.0 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 imply another 50bps rate cut to 3.75% at the February 19 meeting and the policy rate to bottom at 3.00% over the next 12 months.

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