The US threat of aluminum and steel tariffs and reciprocal tariffs initially shook the markets, but the implementation at some future date gives the impression that the threats are negotiating ploys helped take away the sting. In his first term, Trump converted some of the tariffs to quotas, and that is one possible scenario now. Still there is great uncertainty of the US intent and strategy. For its part, the greenback finished last week lower against all the G10 currencies but the Japanese yen. It is not coincidental that US rates also fell last week. Despite the upside surprise to US CPI and PPI, many concluded that CPI was particularly noisy, and the inputs into the PCE deflator suggests the Federal Reserve's targeted measure may slip. The Fed funds futures finished the week with greater confidence of a cut by the end of Q3 than it did before the inflation gauges were reported. Still, the dollar's pullback seems more corrective than a trend reversal and the tariffs still loom on the near-term horizon.
The lack of visibility given what still seems to be an unpredictable US administration means that short-term market participants do not have much conviction. The bilateral talks between the US and Russia over Ukraine is a bit like the Suez Crisis (1956) where US interests diverged starkly from the UK and France. Now may be the most strained relationship between the US and Europe since then. In a generally light economic calendar in the week ahead, the preliminary February PMI stands out. Canada and the UK report January CPI, and nine different Fed officials are scheduled to speak. The Reserve Bank of Australia is widely expected to begin its easing cycle with a quarter-point move, while the Reserve Bank of New Zealand will likely maintain its aggressive course with its third consecutive 50 bp rate cut.
US
Drivers: There are two dominant forces. The first is divergence. The next Fed cut was fully discounted for July, but after the second consecutive decline in US unemployment, sticky inflation, and indications suggesting the economy continues to grow above trend, despite the disappointing retail sales report. The second is the US tariff threats. Given the role of US multinationals, their foreign direct investment strategy, and their significant role in US imports, tariffs will disrupt them. Nevertheless, the market is still inclined to buy US dollars on tariff threats and sell dollars when the threat subsides or looks more like a negotiating tactic.
Data: There is a full slate of data but nothing that has the heft to materially impact expectations for the trajectory of Fed policy. The general line from most Fed officials, including Chair Powell and Governor Waller, who some see as a possible successor to Powell, have indicated that provided the economy and inflation evolve as expected, there is still scope for lower rates. No fewer than nine Fed officials speak in the week ahead. The potential supply shock if tariffs (and retaliation) will be taken serious by the Federal Reserve as it learns from the experience with the pandemic. The minutes from last month's meeting will likely underscore the Fed's patience. January housing data (permits/starts, existing house sales) will draw some attention, while the February surveys (Empire, Philadelphia, and preliminary PMI) may pose little more than headline risk. The Fed funds futures market now has the next cut fully discounted October, and around a 50% chance of a second cut before the end of the year.
Prices: Despite the higher-than-expected CPI and PPI, the US two- and 10-year yields finished lower last week. It was the fifth consecutive weekly decline in the 10-year yield and the fourth weekly decline in the five weeks for the two-year yield. The Dollar Index fell to a two-month low near 106.80. Stale long dollar positions are being cut amid disappointment that the so-called Trump trade is not working. The next technical target is around 106.35. A break of 106.00 could target the 104.90-105.15 area.
EMU
Drivers: The ECB is widely expected to cut rates at least two more times before the Federal Reserve cuts again. The policy divergence weighs on the euro. Also, Europe still seems ill-prepared to address the powerful challenges posed by Russia, China, and now the US. France and Germany have offered to send troops to Greenland, and even if their purpose is not clear, it is not due to Russia's aggression, or China's wolf diplomacy, but apparently it is a response to the US threat. The US-Russia peace talks appear to shift a large burden to the Europe and many suspect this coupled with increased defense spending, will boost the supply of longer-term European debt.
Data: With Q4 GDP already reported, the December trade and current account data, typically not market movers, are unlikely to draw much attention. New information in the form of the Germany's February ZEW survey and the preliminary February PMI will likely attract more interest. Recall that Germany's IFO survey saw a small improvement in the assessment of the overall business climate and the current assessment, but the expectations component fell. Lastly, the average EU tariff om US imports is about 3%, which is about twice the average US tariff on EU imports.
Prices: Short covering lifted the euro to $1.0515 last week. While it is a new high for the February, the January high was slightly below $1.0535. The euro has not closed above $1.06 since November 12, a week after the US election. The $1.0550 area corresponds to the (38.2%) retracement of the downtrend from late September, the last time it traded above $1.12. Still, we view these euro upticks as corrective in nature rather than a trend reversal.
China
Drivers: Many observers see China as the largest beneficiary of the disruption emanating from the new US administration, despite the tariffs and export restrictions. The Trump administration is not even a month into the four-year term and the tensions with Mexico, Canada, and the EU have rarely been higher. Trump's territorial ambitions and refusal to rule out force to take Greenland and the Panama Canal makes China's wolf diplomacy or Russia's aggression in central and eastern Europe seem less like an outlier. The average US tariff on Chinese imports is higher than the average tariff China imposes on US goods, though there are other market-distorting practices. The PBOC daily reference rate for the dollar shows Beijing is still resisting the downside pressure on the yuan.
Data: China reports new and existing house prices. There are some preliminary signs that China's housing market has begun stabilizing. The prime rates will be set this week but there is no reason to expect a change yet. January FX settlements will also be reported. They have fallen sequentially from December since 2020. In the ten years before the pandemic, FX settlement typically increased in January.
Prices: Rather than decline in the face of US tariffs, offshore yuan has appreciated for the past two weeks and four in the past five. The greenback finished the week near CNH7.25. The January low was closer to CNH7.2345 and the 200-day moving average is near CNH7.22. Over the course of last week, the PBOC set the dollar's reference rate between CNY7.1706 and CNY7.1719.
Japan
Drivers: There are two chief drivers of the exchange rate. First, the yen remains sensitive to the direction of the 10-year US Treasury yield. On a rolling 30- and 60-day basis, the correlation between changes in the exchange rate and changes in the US 10-year yield is higher than the correlation with changes in the 10-year interest rate differential. Second, the yen appears sensitive to speculation about the timing of the BOJ's next hike. Currently, the swaps market as about a 50% chance of it in June and 80% in July. Surveys of economists find a preference for July. Judging from the record of the last BOJ meeting, renewed weakness of the yen could influence the timing.
Data: Japan reports Q4 GDP. It looks to be around the same pace as Q3 24 (~1.2% annualized), but the composition looks different. Consumption may be weaker, and inventories look like a drag. That will be offset stronger business investment and a contribution by net exports. January trade figures are also due. Japan runs an overall trade deficit but has a bilateral surplus with the US of about $72 bln in 2023 and $63 bln in 2024. The January national CPI is due, and the Tokyo report a few weeks ago points to firmer price pressures. Japan will see the preliminary February PMI, but the local market does not seem to react much to the report. That said, the composite PMI has risen for three consecutive months through January and the 51.1 reading is the highest since last September.
Prices: On the back of the rise of US rates in the first half of last week, the greenback recovered from the dip below JPY151 on February 7 to JPY154.80 after the "hot" CPI, but with rates falling following the PPI, and then the disappointing retail sales, the dollar returned to almost JPY152 ahead of the weekend. For the second consecutive week, the dollar finished below its 200-day moving average (~JPY152.70). It may take a break below 4.40% in the US 10-year to push the dollar below JPY152 again. The low from early December was near JPY148.65.
UK
Drivers: So far, the UK appears to have escaped being singled out by the Trump administration. Some suspect, the US will seek for extend the UK's distance from the EU. Prime Minister Starmer had made better relations with the EU an important policy objective. The risk is that the government will try to stay in US good graces and improve relations with the EU and fail to do either. Meanwhile, changes in sterling against the dollar and sterling's changes against the euro are correlated 0.80 over the past 60-day. A six-month peak was recorded in late January near 0.85.
Data: Contrary to the Bank of England's warning of a contraction in Q4, the UK economy eked out a small expansion in Q4 24. The UK has a busy economic calendar. Market-sensitive reports include the latest employment figures, January CPI, retails sales, and the flash February PMI. Given the rate earlier this month and the forward guidance, barring a significant surprise, a cut at the next meeting (March 20) will remain unlikely. That means that the Bank of England will have more data before the next "live" meeting in early May. The swaps market is confident of another rate cut then.
Prices: Sterling had fallen 10% from the late September high (~$1.3435) to the mid-January low (~$1.21). With last week's gains, it met the (38.2%) retracement target near $1.2610. The (50%) retracement and the 200-day moving average are found in the $1.2765-90 area. The December high was slightly higher (~$1.2810). Sterling settled firmly and the five- and 20-day moving averages are trending higher. However, the momentum indicators are getting stretched and sterling settled above its upper Bollinger Band for the first time since last September.
Canada
Drivers: The postpone of the US 25% tariff on Canadian imports sparked the recovery of the Canadian dollar. Canada is the single biggest source of US aluminum and steel imports, and the 25% tariffs would be in addition to the general tariff. The uncertainty what happens next month may deter a further recovery of the Loonie as month-end approaches. At the same time, the US two-year premium over Canada narrowed slightly from the recent peak near 165 bp to around 153 bp, while the 10-year premium narrowed from the record high near 150 bp on February 4 to about 137 bp ahead of the weekend.
Data: Canada reports January CPI. In Q4, Canada's CPI was flat at an annualized pace after falling 0.8% in Q3. The underlying core measures averaged 2.45% in December, down from 3.35% in January 2024. This would be the most important input for the central bank, but the tariff threat is now more salient, the market believes. Canada also reports December retail sales. They are likely to have recovered from the flat November, which was flattered by auto sales; without which retail sales fell by a sharp 0.7%. December portfolio flows are due, as well. In the first 11 months, net purchases by foreign investors average C$16.4 bln a month. In the same period in 2023, inflows averaged C$2 bln a month. During the week, Canada reports housing starts and existing home sales, which typically do to elicit much of a response in the foreign exchange market.
Prices: Since the greenback's spike to almost CAD1.48 on February 3 when US tariffs seemed inevitable, it has pulled back by around 4.35% to reached CAD1.4150 ahead of the weekend. The dramatic position unwind sent the US dollar to its lowest level since mid-December. The US dollar had rallied by around 10.2% from the late September low (~CAD1.3420) to that early February high. The CAD1.4100 area corresponds to the (50%) retracement objective. We suspect the move is nearly over, however. The momentum indicators are stretched, and the lower Bollinger Band was frayed before the weekend. On the topside, previous support near CAD1.4260 may now offer resistance.
Australia
Drivers: The Australian dollar has suffered disproportionately in the US dollar's broad rally since the end of September. The Australian dollar fell near 12.5% from the late September high near $0.6940 to the early February low, slightly below $0.6090. Australia runs a modest bilateral trade surplus with the US (~$17 bln) but so far has remained out of the US crosshairs. Leaving aside Japan, where the BOJ is tightening monetary policy, the Reserve Bank of Australia has the only G10 central bank that has not cut interest rates, and that is about to change.
Data: The RBA meeting on February 18 is arguably the most important event in the week ahead, which also features the important employment report, and the preliminary PMI. The futures market is discounting about an 87% chance of a quarter-point cut, while the Bloomberg survey found 28 of 32 respondents also project a 25 bp cut (also around 87%). The Reserve Bank of New Zealand meets the following day (February 19). The RBNZ easing cycle began last August with a quarter-point cut, but then slashed its cash rate by 50 bp in the last two meetings of 2024. The swaps market is pricing about a 90% chance of another half-point cut, which would bring the cash rate target to 3.75%. Since August 1, 2024, the New Zealand dollar has been the weakest among the G10 currencies, depreciating by almost 3.6%. The Australian dollar, in contrast, is off about 2.2% over the same period.
Prices: The Australian dollar has recovered from the spike low on February 3 slightly below $0.6090 to approach $0.6370 before the weekend. It shrugged off the disappointment that at least one Trump advisor is wary of granting Australia an exemption for its metal exports to the US. Ahead of the weekend, the Aussie took out the January high (~$0.6330) and surpassed the upper Bollinger Band (~$0.6345). The $0.6415 area corresponds to the (38.2%) retracement of the Aussie's drop from the late September high (~$0.6940) to that early February low. Yet, the momentum indicators suggest the upside correction is advanced and likely nearly over. A close back below $.6330 may be an early confirmation.
Mexico
Drivers: The US tariff threat looms on the horizon, and the central bank of Mexico has kept the door open to another 50 bp cut next month. The swaps market is discounting about 100 bp of cuts over the next six months. The market was encouraged by softer than expected January CPI. Moreover, the estimate for the second half of last month suggests price pressures are still moderating. President Sheinbaum response to the US and the tariff threat has won praise in Mexico, even among her critics.
Data: With Q4 GDP already reported, December retail sales are unlikely to move the market. The minutes from the recent Banxico meeting are due. Slowing growth and inflation back within target are encouraging officials to reduce the restrictiveness of monetary policy. However, the central bank does not meet again until March 27. By that time, the US tariff picture may be clearer, and more data will be available.
Prices: The Mexican peso rose by about 1.25% last week, its first back-to-back weekly gain of the year. The US dollar fell to MXN20.2625 ahead of the weekend its lowest level since January 24, when it briefly traded slightly below MXN20.1350. It has not traded below MXN20.00 since last November. Since the spike high on February 3 (~MXN21.2930), the greenback has depreciated by about 4.85%. The momentum indicators are consistent with limited near-term downside.
Reviewed by Marc Chandler
on
February 15, 2025
Rating:
