Markets Wobble Over Trade Clash

• Worsening trade dispute is weighing on financial market risk sentiment.

• Cooler US inflation hardly moved the dial on rate expectations. PPI is up next.

• BOJ Governor Ueda reaffirmed the bank’s resolve to shrink its holdings of JGBs. JGB yields recover, and JPY is outperforming.

USD is a little firmer mostly against cyclical sensitive currencies while US and European equity futures are lower. Worsening trade disputes is weighing on financial market risk sentiment. US President Donald Trump said “of course I’m going to respond” to the European Union's countermeasures against his new 25% tariffs on steel and aluminum. Nevertheless, the growth outlook advantage has shifted away from the US to other advanced economies. This regime change is a cyclical drag on USD.

Risk of a US government shutdown will likely have a minimal impact on markets. Lawmaker must reach a deal on a stopgap spending bill and pass it through Congress before Friday night. Failure to act could lead the US government to temporarily close. In the past, shutdowns lasted only a few days minimizing the drag on the economy. Moreover, there are ways for the US Treasury to keep paying its bills for several more months before the severe consequences of a debt default becomes an issue.

US inflation cooled more than expected in February but that did not move the dial on US interest rate expectations. Both headline and core CPI dipped 0.2pts to 2.8% y/y (consensus: 2.9%) and 3.1% y/y (consensus: 3.2%), respectively. Core CPI inflation is the lowest since April 2021. Super core CPI (core services less housing), a key measure of underlying inflation, eased to 3.8% y/y vs. 4.0% in January, the lowest rate since October 2023.

Fed Chair Jay Powell stressed last week “Inflation can be volatile month-to-month, and we do not overreact to one or two readings that are higher or lower than anticipated.” Indeed, Fed funds futures continue to price-in about 75bps of cuts this year, which is in line with the FOMC median Dots.

The US February PPI (12:30pm London) will offer a preview of the February PCE data due March 28. Headline PPI is expected at 3.3% y/y vs. 3.5% in January while core PPI is expected at 3.5% y/y vs. 3.6% in January. Watch out for PPI ex-trade, transportation, and warehousing as it feeds into the PCE. In January, this measure fell to 4.1% y/y, the lowest since February 2024.

For reference, here’s a list of the PPI components used for PCE calculation: Airline passenger services, portfolio management, physician care, home health, hospice care, hospital outpatient care, hospital inpatient care and nursing home care.

The US Q4 household balance sheet report will also be reported today (4:00pm London). In Q3, net worth increased by roughly $4.8 trillion driven by higher corporate equity value after rising $2.8 trillion in Q2. Net worth-to-disposable personal income ratio rose to 778% of GDP from 761% of GDP in Q2 to be just under its all-time high at 833% of GDP in Q1 2022. Strong household balance sheet is a key factor underpinning solid consumption growth.

JAPAN

JPY is outperforming in line with a recovery in 10-year JGB yields above 1.50%. Bank of Japan (BOJ) Governor Kazuo Ueda warned that “the size of the BOJ's monetary base, balance sheet and current account balance is somewhat too big”. The comments are in line with the BOJ’s plan to shrink its holdings of JGBs in half to ¥3 trillion by Q1 2026.

Ueda also signaled that the bar is high for the bank to dial-up the pace of rate hikes. Ueda reiterated he expects real wages and consumer spending to improve but also cautioned that Japan’s inflationary trend that removes temporary factors is still below the BOJ’s 2% inflation target. As such, the BOJ is unlikely to tighten the policy by more than is currently priced which is a headwind for JPY. The swaps market continues to imply less than 50bps of rate hikes over the next twelve months.

CANADA

The Bank of Canada (BOC) delivered on expectations yesterday and cut the policy 25bps to 2.75%. The BOC warned that the “pervasive uncertainty created by continuously changing US tariff threats is restraining consumers’ spending intentions and businesses’ plans to hire and invest.”

As such, unless the trade dispute is fully resolved, the BOC will likely bring down the policy rate below neutral settings which is a drag on CAD. The BOC’s neutral range estimate is between 2.25% to 3.25%. The April Monetary Policy Report will include an update to that estimate. Markets imply an additional 75bps of easing over the next 12 months and the policy rate to bottom at 2.00%.

BOC Governor Tiff Macklem confirmed there was no consideration for a 50bps rate cut. Instead, Macklem’s opening statement stressed “Governing Council will proceed carefully with any further changes to our policy rate given the need to assess both the upward pressures on inflation from higher costs and the downward pressures from weaker demand.”