Tariff Threat Rattles FX Markets

January 28, 2025
6 min read

Tariff Threat Rattles FX Markets

  • President Trump wants “much, much bigger” tariffs than a report suggested. USD rallies across the board. It’s a wasted effort to trade on tariff noise. Stick to fundamentals.
  • This week’s G10 central bank meetings will reassert the monetary policy divergence theme underpinning USD strength.
  • National Bank of Hungary is widely expected to keep rates steady at 6.50% today.

USD recovered across the board on US tariff threat. The Financial Times reported that Treasury Secretary Scott Bessent is pushing for new universal tariffs on US imports starting at 2.5% and move higher by the same amount each month up to 20%. When questioned about that report, President Donald Trump said he wanted “much, much bigger” tariffs.

We once again encourage reader to look at Stephen Miran’s (nominated to head the Council of Economic Advisers) essay “A User’s Guide to Restructuring the Global Trading System” to understand the range of possible tariff/currency driven policies that might be implemented by the Trump administration. A graduate implementation of tariffs is one of the options cited as it would offer credible forward guidance and minimize uncertainty. Moreover, tariffs are unlikely to be uniform across countries. In an article published last October, Bessent proposed putting countries into different groups with different tariff rates based on common security and economic systems. In such a system, trade and national security are joined at the hip.

It’s a fool’s errand to try and trade on the tariff noise. Instead, we focus on the underlying fundamental drivers that favor the dollar regardless of the final tariff plan. This week’s G10 central bank meetings will reassert the monetary policy divergence theme underpinning USD strength. The Fed is expected to keep rates steady at 4.25-4.50% and signal no rush to resume easing (Wednesday). The Bank of Canada is expected to cut the policy rate 25bps to 3.00% following two consecutive 50bps rate reductions (Wednesday). The European Central Bank is expected to cut the policy rate 25bps to 2.75% and stick to its data-dependent guidance (Thursday). Finally, Sweden’s Riksbank is expected to cut rates 25bps to 2.25% (Thursday).

The US January Conference Board consumer confidence index is today’s highlight (3:00pm London). Headline is expected at 105.6 vs. 104.7 in December and would remain within the same narrow range that’s held throughout the past two years. Positive US real wage growth, encouraging labor demand, and strong household balance sheets suggest household spending will remain an important tailwind to GDP growth. Watch-out for the labor index (jobs plentiful minus jobs hard to get). In December, that index rose to a seven-month high at 22.2, suggesting consumers are more optimistic about future labor market conditions. US durable goods orders, house prices, and a couple of regional Fed business surveys are also on the agenda today.

GBP/USD retreated from yesterday’s high near 1.2523 on broad USD strength. UK retail outlet price pressure still in deflation. The BRC shop price index fell -0.7% y/y in January vs. -1% in December on heavy discounting among non-food retailers. With the UK economy weakening and services inflation cooling, the Bank of England has room to resume easing policy. Markets have fully priced-in a 25bps rate cut in February and almost 75bps of total cuts over the next 12 months. Bottom line: BOE/Fed policy trend remains a drag on GBP/USD.

EUR/USD dropped by roughly 1% to lows around 1.0425 on USD strength. Today, the focus is on the ECB Q4 Bank Lending Survey (9:00am London). The data should continue to show that bank lending to both the non-financial corporate sector and households is recovering slowly, reflecting easier monetary policy.

Overall, the Eurozone’s unimpressive growth outlook suggests the ECB has scope to bring down the policy rate towards the middle of its neutral range - estimate at around 1.50% to 3.00% - which is an ongoing drag for EUR. Markets price-in between almost 100bps of total ECB easing over next 12 months that should see the policy rate bottom around 2.00%.

AUD/USD is down over 1.3% from Friday’s high of 0.6330. China’s sluggish growth outlook and broad USD strength are weighing on AUD/USD. The modest improvement in Australia’s December NAB business survey does not move the dial on near-term RBA rate expectations. Business confidence edged up 1 point to -2 but remains well below the long-run average of 4.9. Business conditions rose 3 points to 6 and almost returned to the long-run average of 6.6.

Australia’s Q4 CPI print (tomorrow 00:30am London) will either lock-in a rate cut at the next meeting February 18 or give the RBA space to delay the start of easing a bit longer. Headline is expected at 2.5% vs. 2.8% in Q3, reflecting the government’s cost-of-living subsidy measures introduced in July 2024. The more policy-relevant trimmed mean CPI is forecast to ease 0.2pts to 3.3% in Q4 and track slightly below the RBA’s projection of 3.4%. Slower trimmed mean CPI inflation would seal the deal for a rate reduction and further weigh on AUD. Markets price in roughly 80% probability of a 25bps RBA cash rate cut in February.

NZD/USD is down about 1.2% from Friday’s high near 0.5723 on USD strength. RBNZ Chief Economist Conway speaks later today (10:00pm London). The title of his speech is “Beyond the Cycle: Growth and interest rates in the long run”. Conway will likely stick to the RBNZ’s guidance for another 50bps rate cut to 3.75% in February and a slower pace of easing after that. The RBNZ has already flagged it does not forecast to slash the policy rate below neutral (around 3%) throughout 2027. Markets agree and price in the Official Cash Rate to bottom between 3.00% and 3.25% over the next 12 months.

National Bank of Hungary is widely expected to keep rates steady at 6.50% (1:00pm London). At the last meeting December 17, the bank delivered a hawkish hold. Only one MPC member recommended a rate cut, suggesting the bar for the bank to resume easing is high. Indeed, the bank emphasized that “geopolitical tensions, volatile financial market developments and the risks to the outlook for inflation warrant further pause in cutting interest rates.” The market is pricing in one 25bps cut over the next 12 months.

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