Week Ahead: US Growth Worries and Europe's Fiscal Initiative Weaken American Exceptionalism's Bull Case

The combination of continued growth concerns in the US and the fiscal/defense initiatives in Europe saw the dollar fall every day last week. The Atlanta Fed's GDP tracker says the US economy is contracting at an annualized rate of 2.4%, which seems exaggerated. After falling by about 50 bp in a seven-week slump, the US 10-year yield rose by about 15 basis points last week. Eurozone 10-year benchmark yields rose around 35 bp. The US premium on two-year rates narrowed, which have also contributed to the weaker greenback. The ECB cut its key rate by 25 bp last week and the Bank of Canada is likely to do the same in the upcoming week. However, over the course of the remainder of the year, the market sees the Fed will likely cut more than most other central banks. The Fed funds futures has two rate cuts fully discounted and about 65% chance of a third. 

The highlights for the week ahead include inflation figures from China and the US. China's CPI may have fallen back into deflation, while the US CPI and PPI may have ticked down. Canada's Liberal Party will choose a successor to Trudeau and Carney is tipped to win. He may call for a snap election. The Bank of Canada meets, and a rate cut seems most likely given the shock emanating from the US. The UK reports January GDP and it may have eked out a 0.1% expansion. The EU finance ministers meet at the start of the week with the fiscal initiative the topic de jour. 

US

Drivers:  The US tariff threats and implications are a key force driving volatility and uncertainty in many corners of the global capital markets. Not totally unrelated, after a series of disappointing data, heightened concern about the outlook for the US economy has brought forward the market's confidence of a rate cut in June.  It expects another cut by the end of Q3 and around 60% chance of a cut in Q4 (the median in the Fed's December "Summary of Economic Projections" was for two cuts). Note that March 15, the US debt ceiling will be reached, and a government shutdown remains possible as this is written. The longest government shutdown took place during President Trump's first term, even though the Republican Party had control of not only the executive branch but also a majority in both houses of Congress. Separately, though not totally unrelated to US developments, the fiscal signals from Europe spurred a dramatic rise in interest rates and spurred a sharp narrowing of the US premium. 

Data:  Attention turns to the US prices this week. Wednesday is a key day. The US could implement that tariffs it threatened last month on steel and aluminum. President Trump has also mentioned copper, and it is not clear if it will be included. If the US does not levy the tariffs, then it reinforces that sense that it is a blunt negotiating tactic. The US February CPI is due. The month-over-month rate may slow a little, the year-over-year rates look softer at 2.9% and 3.2% for headline and core, respectively. Both would be 0.1% below the 12-month pace in January. The PPI is out the following day. The headline pace is likely to slow to around 3.2% from 3.5% year-over-year, while the core rate looks steady at 3.6%. Components from the two reports will be used to forecast the PCE deflator that the Fed targets. A few other reports may draw attention including the federal budget (the deficit was slightly more than $296 bln in February 2024), Q4 household net worth (which is likely to show that despite the US-as-victim narrative that seems to have gone viral, America in aggregate has never been richer), and the preliminary March University of Michigan survey. Last month's survey showed a deterioration in sentiment and a jump in inflation expectations. 

Prices: Narrowing of the US interest rate premium amid continued concerns about the US economic health sent the Dollar Index sharply lower last week. The momentum indicators are stretched and DXY settled below its lower Bollinger Band (~104) for the third consecutive session ahead of the weekend. Chart support is not seen until closer to 102. A close above 104.40 would help stabilize the tone. 

EMU

Drivers:  The broader dollar reaction to the US tariff threats (and otherwise) and the implications of the US siding with Russia, as it did at the United Nations last month, are the context for European interest rates and exchange rates. The other critical development has been the stepped-up spending planned in Germany (500 bln euros, 11.4% of GDP over the next decade) and more relaxed EC attitude about government budget shortfalls if driven by defense spending. We suspect that an opportunity for joint bond issuance may be been missed. Core European benchmark 10-year yields jumped 34-35 bp last week as the prospects for growth, inflation, and supply are taken into account. Tail risks have lessened. The US two-year premium over Germany narrowed by 21 bp last week, its fourth consecutive weekly decline, and the largest weekly drop since August 2022. The US premium has fallen by around 50 bp over the streak and now near 175 bp is the least in five months. EU finance ministers meet Monday and Tuesday to flesh out the new fiscal stance. 

Data: The economic calendar is light. It features the aggregate January industrial production and Germany's January trade figures. The market looks for the eurozone to grow by around 0.2% here in Q1. After last week's ECB meeting and updated forecast, the market has about a 60% chance of another cut at next month's meeting, which would bring the deposit rate to 2.25%. The swaps market has the year-end rate near 2.0%, up from about 1.80% in late February. 

Prices: The euro had its best week since 1990. It rose to almost $1.0890, its best level since the day after the US election in early November. The momentum indicators are stretched and the euro settled above its upper Bollinger Band (~$1.0795) for the fourth consecutive session ahead of the weekend. Above $1.0940 little on the charts to deter a test on $1.10. Initial support is seen near $1.08 and then $1.0765. 

CHINA

Drivers:  The US has now imposed another 10% tariffs on Chinese imports, which includes Hong Kong. Research by Federal Reserve economists found that the 20% increase in trade costs for all Chinese imports would boost US inflation by 0.5 percentage points in the first year. It is largely unwound after a year, but inflation remains 0.1 percentage point higher because of the impact on intermediate goods. Other economists expect that the demand destruction will lessen the inflation impact. 

Data:  China reports its February CPI and PPI shortly after this commentary is posted. In H2 24, China's CPI at an annualized pace was flat. Goods prices rose at an annualized rate of 3.4% in the second half of last year. Deflation in producer prices began in Q4 22 and was -2.3% year-over-year in January. It may have moderated toward -2.0% in February, which would be the least since last August. China may report February lending and direct investment this week. 

Prices: The dollar fell by about 0.66% against the offshore yuan last week. It was the largest decline in six weeks. The greenback fell to about CNH7.2280 to approach last month's low (~CNH7.2260) and the 200-day moving average (~CNH7.2220). The dollar has not traded below this moving average since November 8. Meanwhile, the PBOC has set the dollar fix fairly steady since January 21 between CNY7.1691 and CNY7.1745--seen last Monday. The offshore yuan is up about 1.4% year-to-date.

Japan

Drivers: The recent price action has weakened the usually robust correlation of the changes in the 10-year Treasury yield and the dollar-yen exchange rate. The rolling 30-day correlation hovered around 0.70 in mid-January through mid-February but is now near 0.50. The swaps market has about an 80% chance of the next hike in July, but it is not fully discounted until September.

Data:  Before the markets open on Monday, Japan reports January labor earnings. The BOJ has linked the normalization of policy to inflation and sees labor earnings as an important component. Adjusted for inflation, real cash earnings are weak but not negative as they have been mostly since the end of 2021. However, December's 0.6% rise year-over-year was cut in half in an earlier revision. Japan also reports January trade and current account early Monday. There is a strong seasonal pattern for the current account balance to deteriorate in January over December but improve February. Despite the yen's weakness on various valuation models, and the oft-repeated claims about Japan's export reliance, the fact of the matter is on a balance-of-payments basis Japan has recorded a trade deficit for the past three years. 

Prices:  With the post-jobs’ dollar decline, the greenback nicked the (61.8%) retracement objective of its rally from last September through early January, found near JPY147.00. There were $1.1 bln in options struck there that expired ahead of the weekend.  However, the dollar recovered toward the session high above JPY148 after Fed Chair Powell expressed little immediate concern about the economy, which saw a recover in equities and US dollar even as the two-year and 10-year notes gave up their earlier gains and yields settled 4-5 bp higher, around what they were down before Powell spoke. The 10-year JGB yield rose above 1.5% for the first time since 2009. Meanwhile, the US 10-year premium over Japan narrowed to about 271 bp, the lowest since August 2022. It has been over 350 bp two months ago.  It may be forging a bottom.  

UK

Drivers: The broad dollar direction sets the tone. After falling roughly 10% from late September through mid-January, sterling recovered in line with the greenback's larger retreat. Trump asserts the EU was created to hurt the US, and Brexit creates new opportunities. The US tariffs could seek to facilitate a further break, while Europe's defense needs may could allow new cooperation between the UK and EU. Helped by the sharp rise in European rates over the UK weighed on sterling against the euro.

Data:  The economic calendar is light until the end of the week's January GDP report. The UK economy struggled in H2 24. The economy was stagnant in Q3 and eked out 0.1% growth in Q4. Growth is seen picking up to about 0.3% this quarter, but it may be front-loaded. The market accepts that there is practically no chance of a rate cut at the March 20 BOE meeting, but the swaps market is discounting around an 80% chance of a cut at the next meeting (May 8). 

Prices: Sterling's roughly 2.65% rally last week was the largest since November 2022. It reached $1.2945 before the US employment data. It was the fourth weekly gain in five weeks. It found support a little below $1.2900. It is bumping against the upper Bollinger Band (~$1.2930). The next resistance band is $1.3000-$1.3050.  Momentum indicators are stretched. A break of $1.2850 would be the first sign of an impending downside correction.  

Canada

Drivers:  The dramatic reversal of the US stance under the new administration is a negative shock for Canada. Growth looks set to slow. The Canadian economy created only 1.1k jobs in February. Full-time jobs fell by almost 20k, the most since last August. The unemployment rate stands at 6.6%, up from 5.9% in February 2024. With the USMCA waver until April 2 on US tariffs, the White House estimated that 42% of US imports from Canada are still subject to the tariff, though we suspect this is a bit exaggerated as some goods covered by the most-favored-nation status may also be covered by the USMCA. Still, the US is pressing Canada on many fronts, and the broader tariff threat remains.  Before the weekend, Trump threatened Canada with reciprocal tariffs and tariffs on dairy and lumber soon.  

Data: Politics and economics are center stage this week. The week starts with the end of the Liberal Party leadership contest. Former Bank of Canada and Bank of England Governor Carney is expected to win handily. There is risk that the new Prime Minister will seek a snap election to secure a popular mandate. The Bank of Canada meets on Wednesday, March 12. After last week's US tariff announcement, the swap markets boosted the odds of a rate cut to around 85% from about 50% at the end of the previous week. 

Prices: All the G10 currencies rose against the US dollar last week. The Canadian dollar was the laggard with almost a little less than a 0.70% gain. The Australian dollar was second worst with around a 1.5% gain. The US dollar bottomed on Thursday near CAD1.4240 and it recovered ahead of the weekend slightly through CAD1.4425, under the new tariff threat by Trump but pulled back to around CAD1.4365.  A close above CAD1.4400 could signal a retest on last week's high near CAD1.4550, which was the (61.8%) retracement of the greenback's decline since the February 3 spike to almost CAD1.48. 

Australia

Drivers: Fears that the US-sparked trade war will adversely impact global growth weighed on the Australian (and New Zealand) dollar in the first half of last week, but European defense spending initiative helped the Antipodean currencies recovered in the second half of last week. The 30-day rolling correlation between changes in the Australian dollar and Canadian dollar exchange rates is near 0.78 and about -0.55 with the Dollar Index. 

Data: The economic calendar features a few surveys this week, but nothing that typically moves the markets. The central bank meets next on April 1. The labor market report on March 20 and the February CPI on March 26 are the next important data points. 

Prices: The Australian dollar posted a bullish outside up day on Tuesday as it recovered from the dip below $0.6200. It reached almost $0.6365 on Thursday before pullback to nearly $0.6280 ahead of the weekend. The momentum indicators are mixed. The Aussie may not be interesting as it hovers near the middle of the mostly between $0.6200 and $0.6400 range. 

Mexico: 

Drivers:  The US granted another reprieve to Mexico. This time, the President Trump cited the USMCA. The exemptions are expected to last until April 2. The US tariffs are the most pressing challenge facing the Mexican economy, but the economy contracted in Q4 24. Mexico's development model was predicated on the continental integration achieved primarily at hands of US multinational corporations. However, Mexico's economy also has weakened under the pressure of high rates and with inflation back within target (though a little firmer in February), the central bank has scope to continue to cut rates. It meets next on March 27, and the market favors another 50 bp cut. Mexico President Sheinbaum had planned on announcing retaliatory tariffs on March 9, but the new reprieve means that she will hold fire. 

Data:  There is one real sector report in the coming days, January industrial production, due March 13. The 1.37% drop in December 2024, was the largest decline since November 2023. It can be expected to have stabilized, with the help of the first rise in vehicle production in three months in January. After contracting by 0.6% in Q4 24, the median forecast in Bloomberg's survey is for 0.2% quarter-over-quarter growth here in Q1 25. 

Prices: The US dollar spiked to almost MXN21.00 last week but as the US tariffs were again postponed, it pulled back to MXN20.21, slightly ahead of last month's low near MXN20.2015. It is consolidating in quiet turnover before the weekend. The carry is still attractive. Mexico's one- and three-month cetes yield about 9.10%, which is more than twice the yield of comparable US bills. Benchmark three-month implied volatility is near 12.7%. This is the lower end of where it has traded since last June. 

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