Tariff Tantrum Part II

February 04, 2025
6 min read

Tariff Tantrum Part II

  • US President Donald Trump delayed tariffs on Canada and Mexico to March 4. CAD and MXN retraced some of their steep losses.
  • US 10% blanket tariffs on Chinese goods are now in force. China retaliates with tariffs on US products.
  • It’s a wasted effort to trade on tariff noise. Stick to fundamentals which favors additional USD strength.

US President Donald Trump’s decision to pause tariffs on Canada and Mexico for 30 days triggered a 2% pullback in USD/CAD and almost 4% drop in USD/MXN. Regardless, the uncertainty around whether wide-ranging tariffs will ultimately be imposed, and the specifics of those tariffs will continue to weigh on CAD and MXN.

Meanwhile, an intensification of protectionist policies is a downside risk to global growth and can further weigh on risk assets. Following the US 10% tariff on Chinese goods, China slapped a 15% levy on US coal and liquefied natural gas, 10% tariff on US 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.” Stay tuned for more twists and turns.

US

It’s a fool’s errand to try and trade on the tariff noise. Instead, focus on the underlying fundamental drivers that favor dollar strength regardless of the tariff outcomes. The US economy is in a good place and inflation stalling above 2%, suggesting the bar for additional Fed funds rate cuts is high. Fed funds futures continue to imply about 50bps of total easing in 2025, with the next full 25bps cut priced-in for July. The Fed will struggle to deliver on those easing expectations.

The US manufacturing sector expanded for the first in January after 26 months of contraction. The ISM manufacturing PMI improved more than expected to 50.9 (consensus: 50.0) vs. 49.2 in December. The details showed price pressures quickening, demand growing, and employment recovering.

Today, the US December JOLTS data should remain consistent with a healthy labor market (3:00pm London). Job openings are expected at 8,000 mln vs. 8,098 mln in November. The ratio of job openings to unemployed is at 1.1 which is historically pretty strong. That ratio has been above 1 only three times since 1960. Encouragingly, the job opening rate remains above the 4.5% threshold that should keep the unemployment rate quite low in historical terms.

The Fed is in no rush to resume easing. Atlanta Fed President Raphael Bostic (non FOMC voter) stressed yesterday “I'm prepared, and I'm comfortable and very satisfied, to wait for a while [before cutting rates again] and that would be fine.” Bostic speak again today (4:00pm London) followed by San Francisco Fed President Mary Daly (non FOMC voter) (7:00pm London).

EUROZONE

France Prime Minister Francois 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 75bps after topping-out near 90bps in December last year.

Political paralysis in France and Germany means the ECB will have to do the heavy lifting to support the Eurozone economy. The market is pricing in almost 125bps of total easing over the next 12 months that would see the ECB policy rate bottom at 1.50% vs. 2.00% last week. Bottom line: narrowing EU-US 2-year bond yield spreads is an ongoing drag for EUR/USD. There are no policy-relevant Eurozone economic data releases today.

UK

UK-EU relations are warming-up. European Commission Ursula von der Leyen confirmed a first 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. A new UK-EU special partnership is one of our main 2025 macro themes.

SWEDEN

Riksbank minutes from the January policy meeting is due today (8:30am London). At that meeting, the Riksbank delivered on expectations and cut rates 25bps to 2.25%. According to the post-meeting statement “The Executive Board assesses that the forecast for the policy rate made in December essentially holds, but is prepared to act if the outlook for inflation and economic activity changes.”

In December, the Riksbank projected the policy rate to through at 2.25%. In contrast, markets price-in a lower terminal policy rate between 1.75% and 2.00% over the next 12 months. Sweden’s benign inflation backdrop suggests it’s too soon for the Riksbank to pause easing. Bottom line: Fed/Riksbank policy trend favors a higher USD/SEK

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