April 2025 Monthly

The world is different. After a four-year restoration of the traditional globalist US elite, a majority of the American electorate seems to have rejected it. President Trump is indeed a transformational president, and his reversal of many traditional elements of US domestic and foreign policy are triggering dramatic action in other parts of the world. 

Many Americans and European had been critical of Germany's self-imposed fiscal strait jacket   In March, Berlin adopted a 500 bln euro infrastructure campaign and will no longer include military spending in the calculation of the debt break.

The European Commission is moving to allow members to have greater fiscal leeway. The UK's Labour government has opted to boost defense spending by cannibalizing its foreign aid budget. The Polish government is seeking nuclear weapons, either its own or foreign deployment. By the end April, Europe is expected to announce a "reassurance force" for Ukraine. Several countries have offered some trade concessions in hope of avoiding, or at least minimizing, US tariffs. 

The UN vote, which for the first time the US sided with Russia, Iran, and China over Europe on a security issue, signals the greatest crisis in the Atlantic alliance since at least the Suez Crisis (1956). The territorial overture to Greenland, part of NATO-member Denmark, sparked some talk of the deployment of European forces, whose purpose would not be to deter China or Russia. Trump's actions and threats have given UK Prime Minister Starmer an excellent opportunity to re-boot the UK-European relationship post-Brexit.

Trump's harassment of Canada, a member of the British commonwealth, though Starmer and apparently King Charles did not raise this issue in defense Canada in talks with Trump, shifted the balance in Canadian politics. Trudeau was in a precarious position and his resignation as Liberal Party leader was driven by domestic developments and considerations.

However, Carney, the former governor of both the Bank of Canada and the Bank of England is the new prime minister and Liberal Party voters appeared to see him as the most capable to deal with Trump. Conservative Party leader Poilievre was running ahead in the polls but now the Liberals under Carney seem more likely to win the April 28 election. Regardless of the election outcome, the US insult and threat will likely spur Canada to develop closer ties with Europe and is reportedly fueling consumer and tourist boycott in both.

Trump's key claim is that America's traditional allies have taken advantage of it more than its traditional rivals. His wrath appears more aimed at them that Russia or China. He asserts that the EU was created to "screw" the US, though the historical record tells a different story, and US officials often encouraged the integration of Europe, even as it pushed back against proposals for a European army or dollar rival.

Many Americans do seem to believe that the chronically large trade deficits reflect unfair foreign trade practices that are making the US poorer. Yet, it is difficult to square this with the economic data. It is true that the US has been running a current account deficit since 1982, while Japan has been reporting a surplus since 1981 and Germany since 2002. Yet, the US economy has consistently outperformed them. US real GDP per capita rose at an annual rate of 1.8% between 1980 and 2023. In contrast, real per capita GDP rose at 1.4% pace in Germany and 1.5% in Japan.

Moreover, a significant portion of US imports come from the foreign affiliates of US-headquartered companies. For historical reasons, US companies pursued a strategy foreign direct investment strategy rather than a traditional export-oriented approach to serve foreign demand. Since the US data began more than 60 years ago, sales by affiliates of US multinationals outstripped US exports by magnitudes. 

To be sure, and contrary to conventional wisdom, the critical driver is not cheap labor. After all, US foreign direct investment and the employment by the affiliates of US companies are greater in the G10 economies than in sub-Saharan Africa. A better explanation is that US foreign direct investment is more likely to be in or near important customers and markets, which are often in higher income economies.

To overcome US and European protectionism of 1980s and a strong yen, Japanese auto and parts companies adopted a direct investment strategy as well. They too did not move to sub-Saharan Africa or the interior of South America, or the Caribbean, but also located near their most foreign market, the US. This includes Mexico. 

In his first term, Trump renegotiated the North American Free-Trade Agreement (NAFTA) and replaced it with the USMCA (US, Mexico, Canada Agreement) with more robust domestic content rules, which encouraged US, European and Japanese companies to locate production in the free-trade area. Now, in an apparent reversal, the Trump administration argues near-shoring and friend-shoring are not good enough. Only onshoring will suffice. 

On April 2, the US is expected to announce details of its reciprocal and possibly more sectoral tariff strategy. The administration appears to have two conflicting goals. One is to reduce trade barriers for US goods, promoting exports. The other is to raise revenue to help fund the tax cuts it is pursuing which go beyond simply making permanent the Tax Cuts and Job Program of the first Trump's first term. The more successful the first is, the less success the second can be.

Bannockburn's World Currency Index (BWCI), a GDP-weighted basket of the 12 currencies of the 12 largest economies, rose by about 1% in March. It was the third consecutive monthly gain and the largest since November 2023. This reflects the appreciation of nearly all the currencies against the dollar. The South Korean won, which lost about 0.5% was the exception to the generalization. The Japanese yen eked out a minor gain through March 28, and the Chinese yuan was nearly flat. It rose by about 0.2%. 

Among the G10 components, the euro's 4.1% gain was the strongest, followed by sterling rise of a little more than 3%. Among the emerging market members, the Russian ruble's nearly 6% advance was the strongest, while the Indian rupee and Brazilian real rose more than 2%. The BWCI peaked on March 18 at a four-month high, the same day the Dollar Index recorded a five-month low. 

The dollar's weakness in Q1 coincided with a pullback in US equities. European investors bought a record amount of US shares in 2024, which helped lift the greenback. That process seems to have been reversed in this year. Also, interest rate differentials move against the dollar. The US two-year yield fell by about 30 bp, while the German two-year yield slipped by about five basis points and Japan's two-year yield rose by a little more than 25 bp. Even more dramatic was the 10-year rate moves. The US 10-year yields fell by the around 30 bp, the same as the two-year, but with fiscal expansion plans, eurozone 10-year rates rose 25-35 bp, a little less than 15 bp in the UK, and the 10-year JGB yield increased by a little more than 45 bp. 

U.S. Dollar:  Russia's invasion of Ukraine in 2022 was a shock. Decoupling from China 2023-2024 was another shock. A third shock is emanating from the US as the new administration reverses many traditional positions and launches a trade war, seemingly aimed at US allies, but it is also an assault on US multinational companies’ foreign direct investment strategy that entails servicing foreign demand more by producing locally than exports. The US has suspended its $25 mln financial contribution to the WTO, which is more symbolic than a budget savings. Reciprocal tariffs, which the administration says will take into account not only tariff differentials, but also non-tariff barriers to trade, are to be announced April 2. More sectoral tariffs, including on lumber, copper, semiconductors, and pharma have also been threatened though the dates are no known. The certainty of some tariffs and the uncertainty of others have seen consumer confidence implode. The net result is likely to be weaker growth and firmer prices. Ultimately, we suspect the former will spur the Federal Reserve into resuming its easing cycle that began last year. In addition to tariffs, significant government layoffs and the crackdown on legal immigration will also act as headwind on economic growth. Meanwhile, Canada and Europe appear to be engaged in a consumer boycott against the US, which includes a sharp drop in tourist plans. This could also lead to further deterioration of the US trade balance as tourism is understood to be the export of hospitality services. 

Euro:  March may have been turning point for Europe. Faced with growing threats from the United States, the new German government announced a 500 bln euro 10-year infrastructure initiative and removed defense spending from its debt brake. The EU is moving toward granting greater fiscal flexibility to its members, with similar emphasis as Germany--infrastructure and defense. This shift, which reduces the downside tail risks, at the same time as the eurozone composite PMI gradually recovers, spending Q1 25 above the 50 boom/bust level, and German sentiment improves. Eurozone 10-year yields rose by about 30 bp in March but the periphery premium over the core did not increase, as it often does in a rising interest rate environment. The ECB delivered its sixth rate quarter-point rate cut in the easing cycle that began last June. The deposit rate now stands at 2.75%. ECB President Lagarde has suggested the neutral rate is around 1.75%. The swaps market is pricing in about almost an 85% chance of another quarter-point cut in April, but the pace is expected to slow. The market has one cut fully discounted in H2 25. The terminal rate is seen near 1.75%. 

(As of March 28, indicative closing prices, previous in parentheses)  

Spot: $1.0825 ($1.0375) Median Bloomberg One-month forecast: $1.0755 ($1.0300) One-month forward: $1.0845($1.0395) One-month implied vol: 7.6% (7.6%)  

Japanese Yen:  The dollar bottomed against the yen on March 11 near JPY146.55, its lowest level, a five-month low, a day after the premium the US offers over 10-year JGBS was squeezed to its narrowest since August 2022. As US rates and the premium over Japan widened, the greenback recovered toward the March high (JPY151.30). We look for the dollar to pullback toward JPY148.50-JPY149.00 as we anticipate that the US real sector data will catch-up to the weakness seen in recent survey data. The Japanese economy is off to a poor start this year, with industrial production and the tertiary activities index (services) contracting in January. Household spending was soft, and the preliminary March composite PMI fell to its lowest since February 2022 (48.5). With core inflation at 3% in February, and well above the 2% target, the Bank of Japan remains in a tightening mode, but it is not in a hurry. While the swaps market has a little more than an 80% chance that the next hike is delivered in July, up slightly in recent weeks, the next rate hike is not fully discounted in the until October. 

Spot: JPY149.85 (JPY150.65) Median Bloomberg One-month forecast: JPY149.25 (JPY152.00) One-month forward: JPY149.35 (JPY150.10). One-month implied vol: 9.4% (10.8%) 

British Pound:  The dimmer economic prospects prompted the Chancellor of the Exchequer Reeves to cuts spending and rely on tackling tax avoidance to maintain the fiscal buffer of almost GBP10 bln that was identified last fall. The Office for Budget Responsibility cut this year's growth forecast in half to 1%. It sees almost a 50% chance that the targets are missed, forcing more difficult decisions in the fall. The US tariffs and a most rise in borrowing costs could be the catalyst. The recently announced US auto tariffs could impact almost a fifth or around $12 bln of UK auto exports. The UK may be vulnerable to the reciprocal tariff threat. While US and UK tariffs on each other’s goods are nearly the same, the UK has a 20% VAT, which the US administration argues gives it an unfair trade advantage. The UK may also be vulnerable if the US seeks to offset the UK digital tax through tariffs. The Bank of England meets next on May 7 and the swaps market is discounting around a 75% chance of a cut, down from 90% probability seen at the end of February. The market has about 50 bp of cuts in the remainder of the year, while at the end of February, there was almost a 40% chance of another cut before year-end. For the last three weeks, sterling has mostly consolidated in a little more than a cent-and-a-half range above $1.2850. The $1.30 level was breached a few times, but it did not get above $1.3015. The breakout of the range will likely indicate the direction of the next 1-2-move. 

Spot: $1.2940 ($1.2575) Median Bloomberg One-month forecast: $1.2900 ($1.2400) One-month forward:  $1.2945 ($1.2580) One-month implied vol: 6.7% (7.5%)  

 

Canadian Dollar:   Canada has been targeted by the Trump administration. It is not limited to tariff threats, but some reports suggest the US is contemplating forcing Canada out of the intelligence-sharing group, Five-Eyes, and makes overtures about incorporating Canada into the US. This has thrown a spanner into the Conservative's electoral hopes. Carney, the former Bank of Canada, and Bank of England governor won the Liberal Party leadership contest, and within two weeks, called for a snap election (April 28). Under Carney, the Liberals are adopting more pro-business platform and jettisoning some of Trudeau's unpopular policies. The polls give the Liberals a small advantage, within the margin of error. The Bank of Canada delivered a quarter-point rate cut in March, and although the monetary cycle is not over, a cut at the April 16 meeting looks unlikely. The US dollar fell for the second consecutive month against the Canadian dollar after rising for five months through January. It was the first back-to-back monthly decline since the end of 2023. The April 2 US tariff announcement is likely more important factor for the exchange rate than the high-frequency economic data. Given the relative size, the trade war will hurt the Canadian economy in the first instance harder than the US economy. This seems to make the Canadian dollar vulnerable. Still, and even after the auto tariff announcement, the US dollar is in the lower end of March's range below CAD1.4300. 

Spot: CAD1.4315 (CAD 1.4460) Median Bloomberg One-month forecast: CAD1.4340 (CAD1.4400) One-month forward: CAD1.4300 (CAD1.4440) One-month implied vol: 6.5% (8.5%)   

Australian Dollar:  The Reserve Bank of Australia began its easing cycle in February but has signaled a cautious approach. It is most likely to stand pat at the April 1 meeting, but the disappointing February employment report that showed a nearly 36k full-time job loss, which practically offset in full the January gain did boost odds of cut at the following meeting on May 20. Cyclone Alfred that hit in early March will adversely impact short-term growth metrics, the labor market, and may keep prices firm. Meanwhile, a national election has been called for May 3. All seats in the House of Representatives and a little more than half of the Senate are at stake. The latest polls suggest that the incumbent Labor Party has improved and is now ahead of the Liberal-National coalition. Prime Minister Albanese hopes to be the first prime minister in a couple of decades to enjoy re-election. Just before the election announcement, he announced tax cuts, an extension of the energy rebate, and an in increase in the threshold at which the tax for the government health-care system is triggered. The budget deficit projected to widen to about 1.5% of GDP from 1.0% in the current fiscal year, which runs through the end of June. The Australian dollar rose by about 1% in March, but it looks vulnerable in the near-term, but the risk-reward is not favorable as it is hovering around the middle of its $0.6200-$0.6400 trading range. It was turned back from its attempt at the year's high seen in February near $0.6410. A break of the $0.6185-$0.6200 area warns of the risk of a return toward the year's low a little below $0.6100. 

Spot: $0.6285 ($0.6210) Median Bloomberg One-month forecast: $0.6290 ($0.6300) One-month forward: $0.6290 ($0.6215)    One-month implied vol: 8.5% (9.9%)  

Mexican Peso:  With inflation back within target and the economy weak, Mexico's central bank delivered two half-point rate cuts in Q1 25. Mindful of these economic conditions, the central bank offered dovish foreign guidance indicating that if the economy evolves as expect, it will deliver another 50 bp cut at its next meeting (May 15). From the dollar's spike peak in early February, when 25% tariffs on Mexico's exports to the US looked imminent to the mid-March low, the US dollar fell by nearly 6.8%. The March low, slightly below MXN19.85, was the greenback's low since shortly after the US election last November. We suspect that marks an important low and see potential in the coming weeks returning to the March high near MXN21.00. President Sheinbaum is winning strong praise for her interactions with the US administration. Her domestic support is over 80%. While Canada is seeking closer ties with Europe, Mexico has fewer options to offset the challenges posed by its northern neighbor. In the month through March 28, the Canadian dollar rose by about 1.25% against the dollar, almost half as much as the peso but to paraphrase Galileo, it did move. And year-to-date, the peso is up 2% while the Canadian dollar has not appreciated by 0.75%. Bolsa rose by nearly 7.5% in Q1 25 compared with less 1% gain in the Toronto Stock Exchange Composite. 

Spot: MXN20.3750 (MXN20.55) Median Bloomberg One-month forecast: MXN20.5350 (MXN20.75) One-month forward: MXN20.46 (MXN20.75) One-month implied vol: 13.0% (13.3%) 

Chinese Yuan:  The Chinese economy continues to lag Beijing's hopes, and this has produced a stream of reform and stimulus measures. None of which has proved to end the deflation or ensure that the growth and inflation targets are met. Yet, the recent technological developments, like DeepSeek and BYD's rapid charging system for electric vehicles and combining AI with robotics has captured investors' imaginations. The index of Chinese companies that trade in Hong Kong is up 18% so far this year, putting it among the top performers. Officials closely manage the exchange rate, and through various means, keep it broadly stable against the US dollar. The dollar was confined to about a 1.6% range in Q1 25 after a 4% range in Q4 24. Officials tolerate a bit more movement in the offshore yuan but have intervened via liquidity in Hong Kong at times to temper it. In Q1 25, the dollar traded about a 2.15% range against the offshore yuan after about a 5.25% range in Q4 24. 

Spot: CNY7.2625 (CNY7.2785) Median Bloomberg One-month forecast: CNY7.2890 (CNY7.3500) One-month forward: CNY7.1800 (CNY7.1855) One-month implied vol: 4.9% (4.8%)

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