Tariff Tantrum
- US President Donald Trump’s tariffs jolt financial markets. USD is up across the board and global equity markets are selling off.
- US January ISM manufacturing survey and Eurozone January CPI are today’s data highlight.
- Check-out our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.
US President Donald Trump’s tariffs jolt financial markets. Trump announced over the weekend tariffs of 25% on imports of Canadian goods and a tariff of 10% on energy imports from Canada. Mexico and China will also be hit with blanket levies on goods of 25% and 10%, respectively. The tariffs are set to take effect Tuesday. Trump is expected to hold talks today with the leaders of Canada and Mexico but stressed there was no opportunity to delay the tariffs.
In response, Canadian Prime Minister Justin Trudeau announced 25% levies on over US$100bn of US goods, Mexican President Claudia Sheinbaum pledged to detail her plan today, and China promised “corresponding countermeasures.” Meanwhile, Trump reiterated that he would be implementing tariffs on goods from the European Union “pretty soon.” The UK is off the hook for now as Trump pointed out the US-UK trade relationship had issues but “I think that one can be worked out.”
The currency market reaction was brutal. USD/CAD surged to near a 22-year high around 1.4800, USD/MXN rallied to almost a 3-year high around 21.3000, USD/CNH made a new cyclical high around 7.3750 and EUR/USD plunged briefly under 1.0200 to the lowest level since November 2022.
A weaker domestic currency against the USD is probably the best response Canada, Mexico, China, and the Eurozone have to minimize the drag from US tariffs on their economies. Notwithstanding the tariffs, 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.
US
The US January ISM manufacturing PMI takes the spotlight today (3:00pm London). Headline is projected at 49.9 vs. 49.2 in December. The regional Fed ISM manufacturing prints point to upside risk. Of note, the US S&P Global manufacturing PMI increased in January to a 7-month high at 50.1 vs. 49.4 in December. Fed speakers today include: Atlanta Fed President Raphael Bostic (non FOMC voter) (5:30pm London), and St. Louis Fed President Alberto Musalem (FOMC voter) (11:30pm London).
EUROZONE
The Eurozone’s January preliminary CPI is up next (10:00am London). Headline CPI inflation is projected at 2.4% y/y vs. 2.4% in December and core CPI inflation is forecast at 2.6% vs. 2.7% in December. The already released regional EU harmonized CPI prints were mixed. Germany’s matched consensus at 2.8%y/y and was steady from December, France’s was a tick lower than expected at 1.8% y/y and was steady from December, while Spain’s was a tick higher than expected at 2.9% vs. 2.8% in December.
The ECB has room to cut rates further which is an ongoing drag for EUR. The Eurozone disinflationary process is well on track and the growth outlook is unimpressive. Indeed, interest rate futures firmed up bets of additional ECB rate cuts last week after Eurozone real GDP unexpectedly stagnated in Q4 and the ECB warned of additional headwinds in the near-term. Markets expect the ECB policy rate to bottom in the next 12 months at 1.75% vs. 2.00% previously.
JAPAN
The Bank of Japan (BOJ) Summary of Opinions from the January 23-24 meeting suggests yen weakness was one factor underpinning the decision to raise rates. Recall, at that meeting, the BOJ delivered a 25bps hike to 0.50%. The Summary of Opinion showed that for one member it was “necessary for the Bank to adjust the degree of monetary accommodation from the viewpoint of avoiding the yen's depreciation and the overheating of financial activities, both of which appear to be due to excessively high expectations of continued monetary easing.” Another member warned that “a rapid depreciation of the yen, as seen through the first half of last year, would not be desirable. On the other hand, due attention is also warranted on the opposite risk that the yen's depreciation will be retraced excessively.”
The BOJ policy rate is still expected to peak around 1.00% over the next two years. 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 remains a major headwind for JPY.
AUSTRALIA
Australia consumer spending was more resilient than anticipated. In December, nominal retail sales fell -0.1% m/m (consensus: -0.7%) vs. 0.7% in November as “Cyber Monday boosted spending early in the month.” In volumes terms, retail turnover increase 1% q/q (consensus: 0.8%) after rising 0.5% in Q3. However, as the RBA points out “the extent to which this reflected a sustained recovery in consumer demand, rather than a pull-forward in expenditure in response to emerging patterns of promotional activity, was not clear.”
Regardless, softer inflation pressures in Q4 support the case for the RBA to start easing at the next February 18 meeting. Markets have virtually fully priced-in a 25bps RBA cut to 4.10% for February and a total of almost 100bps of cuts over the next 12 months. Bottom line: RBA/Fed policy trend and sluggish Chinese economic activity can further weigh on AUD/USD.
CHINA
China’s private sector factory growth traction stalled in January. The Caixin manufacturing PMI undershot expectation and dipped to 50.1 (consensus: 50.6) vs. 50.5 in December. China’s steady drip feed of stimulus has done 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.
