Tariffs Roil Markets

Overview: The US made good on its threats to levy 25% tariffs on Canada and Mexico, and 10% tariffs on China. There still seems to be skepticism in the market, with many thinking the tariffs on Canada and Mexico may not last the week. Trump will reportedly talk with Trudeau and Sheinbaum today. The dollar did not trade high so much it was marked sharply higher in initial activity. That the Canadian dollar and Mexican peso was hit the hardest is not surprising, but the euro, Australian dollar, and Swedish krona drop has been nearly as greater as the Canadian dollar. The South African rand has also been targeted following the US threat to cut all funding to South Africa for a law passed month that gave the government the power to acquire land from private parties if it is in the public interest (eminent domain?).

Equities seemed to do well last week despite the pending tariffs, though pre-weekend activity saw North American markets fall. Today the reality struck. Hong Kong was an island of stability amid sharp regional losses of as much as 3.5% in Taiwan, and more than 2.5% in Japan and South Korea. Europe's Stoxx 600 is off 1.5% to snap a four-day advance. It is the largest decline in over a month. US index futures are pointing to 1.3%-1.6% losses. European benchmark 10-year yield are 4-5 bp lower, while the 10-year US Treasury is little changed near 4.55%. The US two-year yield is up nearly eight basis points to 4.27%, while European two-year yields are off 4-6 bp, and Canada's is eight basis points lower. Gold recovered from its initial sell-off (to ~$2772) and has returned to the $2800 area. The record high set before the weekend was slightly above $2817. March WTI gapped higher and reached nearly $75.20 before stalling. It is hovering near $74 now. 

USD: The Dollar Index gapped higher in response to the tariff announcements. The pre-weekend high was slightly above 108.55, near the 20-day moving average. Today's low is about 109.16. The peak so far was near 109.90. The high from mid-January was a little shy of 110.20. President Trump indicated he will talk with Canada's Trudeau and Mexico's Sheinbaum today. Of today's reports, the ISM manufacturing survey and January auto sales are more important that the final manufacturing PMI and December construction spending. While the preliminary manufacturing PMI rose above the 50 boom/bust level for the first time since last June, the ISM manufacturing reading has not been above 50 since October 2022. US auto sales were relatively strong in Q4 24, averaging a 16.45 mln unit annualized pace, the best since Q2 21, as some tried to get in front of the threatened tariffs. A modest pullback is expected in January toward a 16.2 mln unit pace, which would have knock-on effects for retail sales and consumption more broadly.

EURO: One might think that today's manufacturing PMI and preliminary January CPI would provide fresh trading incentives, but they are overwhelmed by the US tariffs and threats. The preliminary manufacturing PMI (46.1 from 45.1) contained the important signal and today's final estimate was even better at 46.6. In a similar vein, the larger eurozone members reported their harmonized CPI figures last week. Today's aggregate report showing a 0.3% decline on the month and a tick up in the year-over-year rate to 2.5% from 2.4% year-over-year rate means little. The swaps market sees a March cut as a done deal and has about a 10% chance of a 50 bp move discounted. The US two-premium over Germany had been narrowing since late December, but after it approached 190 bp last week, the least since the US election. It recovered in the second half of last week and settled near 209 bp, the most in nearly three weeks. It has surged today to almost 225 bp, the most since late December. The euro fell every day last week, for the first time since last October and finished the week about 1.35% lower. It gapped lower today, and importantly the gap appears on the weekly charts. Friday's high low was about $1.0350 and today's high is almost $1.0310.  It is near $1.0250 in late European morning turnover. 

CNY: Mainland markets re-open Wednesday from the Lunar New Year holiday. The dollar rose in four of last week's five sessions against the offshore yuan. When the onshore market closed on January 27, the dollar was trading around CNH7.24. Ahead of the weekend, the greenback rose above slightly above CNH7.33 before settling slightly below CNH7.32. but still above the 20- day moving average (~CN7.3115). Today, it opened near CNH7.35 and rose to CNH7.3735, a new high since October 2022. It is trading near CNH7.34 in Europe. The Caixin manufacturing PMI was reported. It eased to 50.1 from 50.5. Recall that official manufacturing PMI fell to 49.1 from 50.1.

JPY: The dollar is little changed against the yen today. There was some earlier volatility, but we note that as the US 10-year yield steadied so did the exchange rate. The 10-year US yield is also now little changed from late Friday. The dollar appears to have forged a shelf last week around JPY153.70-80. It recorded lower highs for six consecutive sessions before today, when it reached almost JPY156, a four-day high. The 20-day moving average is near JPY`156.25. The final manufacturing PMI was 48.7 (vs. 48.8 preliminary estimate). It is the lowest since March 2024 and has not been above 50 since October 2022, with the exceptions of the fluke print of 50.6 in May 2023.

GBP: Sterling's two-week bounce off the test on $1.21 on January 13 faltered last Monday after reaching almost $1.2525. It pulled back and recorded the low for the week ahead of the weekend near $1.2385. Today's high is almost $1.2385. It was sold to $1.2250. It is trying to re-establish a foothold above $1.23 in the European morning. The final look at UK's manufacturing PMI provides little added insight. The preliminary reading of 48.2 improved to 48.3 in the final iteration. It is the first uptick since last August. Last January, it was at 46.2. The highlight of the week is the Bank of England meeting on Thursday. A quarter point cut is widely discounted. Two quarter-point rate cuts were delivered in 2024 (August and November). The swaps market has a little more than three cuts priced in for this year. 

CAD:  The US tariff threat to lift the dollar to nearly CAD1.4595 on January 30. News that it would be postponed until March 1 saw it reverse lower to almost CAD1.4370, but only to recover back to nearly CAD1.4560 when the White House indicated it was still proceeding with the tariffs. The greenback posted its highest settlement since 2003. Still, the actual tariff announcement saw the US dollar gap high. It opened on what remains the low of the day near CAD1.4630. The high was almost CAD1.48. The combination of a disappointing 0.2% contraction in November and ideas that US tariffs would exacerbate the economic slowdown saw Canadian yield soften. The US 10-year premium over Canada rose to 147 bp, a record. The US two-year premium widened to 156 bp, the most since 1997. The positioning around and policy response to US tariffs will likely swamp other considerations, including today's manufacturing PMI. With the Liberal leadership contest, parliament has been prorogued (not in session), which means the fiscal response to the economic shock may be slow to materialize, putting more pressure on interest rates. The data highlight of the week is the January employment report on Friday. Overall job growth is expected to slow and the unemployment rate to tick up to 6.8% (from 6.7%). It was at 5.7% in January 2024.

AUD: Support near $0.6200 held last week but the Australian dollar settled near its lows. The Aussie was sold a little below $0.6090 today, a new low since April 2020. It has recovered to about $0.6150 but appears to be stalling. The final manufacturing PMI popped back above 50 for the first time since February 2023. The preliminary reading was 49.8. There are several high frequency reports this week, including retail sales, household spending, and figures. Yet, barring a significant surprise, central bank is expected to (belatedly?) begin its easing cycle on February 18. The swaps market has about 90 bp of easing discounted over the next 12 months. 

MXN: Tariffs loom and yet the peso seemed more resilient than one might have expected. To be sure, it fell by a little more than 2% last week, making it the worst performing emerging market currency. The dollar settled slightly below MXN20.68 before the weekend and today's low is near MXN21.07. It reached high slightly above MXN21.29, its highest level since March 2022. The upside momentum stalled but the greenback may find support above MXN21.00. President Sheinbaum will formally announce Mexico's response to the US tariffs today. The weaker-than-expected Q4 GDP (-0.6% vs. median forecast in Bloomberg's survey for a 0.2% contraction) would appear to boost the chances of a 50 bp cut at Banxico's meeting on Thursday. A 25% tariff on exports to the US clearly be a new headwind for Mexico's economy. However, officials will likely weigh that in the context of the potential inflationary implications of a weaker peso. 

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