April 2, what President Trump called, "Liberation Day" will indeed go down in history. The markets quaked. A trade war with China escalated as Beijing took strong retaliatory measures, with not only a sharp rise in its tariff on US imports but imposed (more) restrictions on rare earth exports. Canada and Mexico were spared the "reciprocal tariffs,” but both made clear declarations of intent to diversify their trade and economic partners. Nixon broke the dollar's last link to gold on August 15, 1971. The dollar remained the numeraire. It still will as there is no other currency or precious metal that can rival in a meaningful way. However, with the tariff announcement on April 2 may usher in a change of different proportions. The US is perceived to shrugging off the mantle of global leadership. And that is true even if the reciprocal tariffs, which seemed to be a simple (and meaningless) function of the size US goods exports relative to of size the bilateral goods deficit, there is an element of soft power that has been lost that will be difficult to re-establish. This seems likely even if the tariffs are a negotiating ploy and not a strategy to raise revenue to fund the tax cuts or a way to re-shore manufacturing.
The week ahead features China and US CPI. China's consumer inflation is expected to have emerged out of deflation in March. It is reasonable to expect the impact of the trade war on China to be broadly similar--lifts price and curtails growth--. While pace of US inflation may slow slightly, Fed Chair Powell seemed to all but rule out at the May 7 meeting. The stronger than expected job growth (228k vs. 165k average in 2024) likely ensures the evaluation is broadly shared. It is still a month away, but he set the bar high even as stocks extended their precipitous decline. In a gaming it out, Powell said don't look to the central bank. Where is the administration's pain threshold? When would Congressional support to challenge the emergency powers, reassert the importance of its consent? We suspect that another week like the past one in which the S&P 500 lost nearly 11% and the Nasdaq dropped almost 12.5% would suffice.
US
Drivers: The trade war is gathering momentum. It generates seemingly conflicting impulses. higher prices and weaker growth. Market participants seem more concerned about the latter than the former. By shifting the focus from the stock market in his first term to bond yields in the second term, President Trump signals he is prepared for some economic disruption, and a narrative of "no pain, no gain," has been put forward. There are two key questions. First, are the reciprocal tariffs a negotiating ploy or primarily a way to encourage onshoring and raise revenue. Second, will the precipitous fall in equities trigger the so-called Fed put, when they respond to the possible negative repercussions on the US economy by cutting interest rates?
Data: US March CPI and PPI are the highlights. The headline is expected to rise by 0 .1%, which will allow the year-over-year rate to slow to 2.6% from 2.8%. The core may rise by 0.3% but given that last March's 0.4% increase will drop from the 12-month comparison, the year-over-year rate can slip to 3.0% from 3.1%. Headline producer prices are projected to rise by 0.2%, which would translate into a 3.3% year-over-year increase (3.2% in February). The core rate may rise by 0.3%, which could lift the year-over-year rate to 3.4% (from 3.2%). The FOMC minutes will be looked upon for some color into thinking about the "transitory" impact on prices from tariffs. Just as the federal government layoffs have yet to be seen in the data, it may be too soon to impact in the March federal budget balance due Thursday.
Prices: While surveys pick concerns about higher inflation, market-based measures, like the difference between conventional yield and the yield of inflation-protected securities have not shown the same anxiety. The five-year breakeven is near 240, bp its lowest level since early January. The 10-year breakeven is near its Q1 average of below 220 bp and its lowest level since last October. Last Thursday's range in the Dollar Index may frame price action in the coming days: ~101.25-103.40. It finished last week with strong momentum above 103.00
EMU
Drivers: The shock from the trade war is a headwind, but the impact will be uneven and partly blunted by the recovery that seemed to have begun and defense/infrastructure spending. It is too soon to talk about a capital strike, but it does appear that the record buying of US equities by European last year is being unwound.
Data: There are a few highlights in the coming days, but it seems that in the current context, it is not so much high-frequency data that are catalysts, but the larger geopolitical and economic environment. Moreover, the ECB's decision on April 17 may not been tied tightly to the upcoming data. Germany and Italy report industrial production figures and France reports its current account. Aggregate eurozone retail sales are due. The swaps market has about an 85% chance of an ECB cut discounted.
Prices: The euro rose by about 1.2% last week, the fourth weekly advance in the past five weeks, though well off the week's high. Given last Thursday's range (~$1.08-$1.1145) and lack of much clarity, consolidation looks to be the most likely as the start of the new week. It finished the week near the highs seen last month and and last November. A break below $1.0900 area may force more late longs out. The euro bottomed in early February near $1.0140 and rallied almost 10% in the past two months. The (38.2%) retracement is near $1.0760.
China
Drivers: Tensions between the US and China are ratcheting higher. China has retaliated with a 34% tariff as of April 10 on all US imports, has banned several products and announced more export restrictions on some rare earths. It also discouraged new investment in the US. The PBOC set the dollar's reference rate at its highest level of year ahead of weekend, seemingly giving the dollar more scope to appreciate (and the yuan to fall). The retaliation has so far been limited to trade and investment, but it does not require much of a stretch of the imagination to see them extending to geopolitics if Beijing probes resolve of Washington. Its military exercises around Taiwan seem particularly aggressive. The previous robust correlation (rolling 60-day) between changes in the Dollar Index and offshore yuan (~0.75 at the end of 2024 to around 0.50 now, and yen (~0.45 at the end of 2024 and less than 0.20 now) have weakened.
Data: China is likely to report new lending figures, but it is the CPI and PPI on April 10 that will draw the most interest. China is experiencing deflation. In such an environment lower rate and a weaker currency are preferred. China's CPI is expected to bounce back after falling by 0.7% year-over-year. If China were more of a market economy, the US tariffs and its own tariffs would likely lift inflation in the first instance.
Prices: We had detected a small change in the PBOC's setting of the dollar's daily reference rate, moving it slightly more than it had been, and the pre-weekend dollar fix was at its highest of the year. It appears to be signaling willingness to tolerate a weaker yuan and the market may give it to them as the path of least resistance. The dollar traded in a wide range over the past two sessions: ~CNH7.24-CNH7.35 and settled higher for the third consecutive week.
Japan
Drivers: The yen tends to move more in line with changes in the US 10-year yield than the 10-year rate differential between the US and Japan judging from the rolling 60-day correlation. Although the BOJ is in a tightening mode and the Fed is pausing in an easing cycle, the correlation of differences is stronger at the 10-year differential than the two-year differential.
Data: Japan reports February's current account on April 8. Without fail for more than 20 years, the February current account always improves sequentially from January. There is no reason to expect that powerful seasonal pattern to break. Japan reported a JPY257.6 bln shortfall in January. The surplus in February has been more than JPY2 trillion since 2016. To be sure, and contrary to the conventional wisdom of Japan's export prowess, the current account surplus (4.8% of GDP in 2024) is not the result of a trade surplus. On a balance-of-payments basis, Japan has not run an annual trade surplus since 2021.
Prices: The drop in US yields saw the dollar fall from JPY150.50 in the middle of the week to JPY144.55 before the weekend, its lowest level since last October. The 10-year Treasury yield recovered more 10 bp after the US employment report and this appeared to help lift the greenback toward JPY147.50 before sellers reemerged. Last week was the fourth week in the past nine that the dollar fell by more than 1.70 % against the yen. Three-month implied volatility reached 12% last week, a new six-month high. The low from late March was around 9.7%.
UK
Drivers: Recently changes in sterling have been more correlated with changes in the US two-year yield than the changes in the two-year Gilt (rolling 30-day correlation of difference is ~0.30 and 0.15 respectively). For two-and-a-half years until earlier last month the 30-day correlation between changes in sterling and the US two-year yield had been negative (e.g., ~-0.65% in late 2024). Still, even strong that rates, the broader direction of the dollar is important. The rolling 30-day correlation is strongly inverse around -0.88. The inverse correlation has rarely been greater.
Data: The UK economy contracted by 0.1% in January, defying expectations for 0.1% growth. Industrial production was surprisingly weak contracting by 0.9%, led by a 1.1% drop in manufacturing output. A recovery is expected to be reflected in the February GDP report on Thursday. Still, the manufacturing PMI fell further into contractionary territory in February (and March). Given the reports of gold shipments, the trade balance will also draw attention. Recall that the January trade balance, excluding precious metals was the UK's first monthly trade surplus since June 2021.
Prices: Sterling spiked to almost $1.32 amid the volatility around the US reciprocal tariff announcement but the gains were unwound in full, and sterling took out support around $1.2950 and fell a little through $1.2860. This is a new low early March. Sterling has come a long way since the mid-January low near $1.2100. The momentum indicators are still trending lower. If sterling experienced a climactic top at the end of last week, the first target may be in the $1.2785-$1.2815 area. One force at would work has been sterling sales against the euro. Despite the EMU having been hit was twice the US reciprocal tariff as the UK, the euro rallied about 2% against sterling in the past two sessions and to around GBP0.8520. The euro is at its best level since last August.
Canada
Drivers: The US dollar's exchange rate against the Canadian dollar has become more sensitive to the changes in the two-year US yield. The rolling 30-day inverse correlation was about -0.50, the most inverse since early 2020, at the end of March. It has been positively correlated for the most of the past three years. The 30-day correlation with the Dollar Index (0.58) is the upper end of the where it was in Q1 25. Its weakest was in early February when it slipped below 0.20, which it has not seen since August 2023. The Canadian dollar has been sensitive to the broader risk climate. Using the S&P 500 as a proxy for risk appetites, the inverse correlation reached 0.50 late last year before reaching almost zero in the first half of February. It is now near 0.10.
Data: The data highlight includes the IVEY and the Bank of Canada survey. The economic shock from the US trade war risks pushing Canada into a recession. The Bank of Canada has been easing policy well ahead of the re-election of Trump. The next meeting is April 16. The market sees about a 1-in-3 chance of a cut and the odds increase to a little over 80% at the following meeting in June. At the end of last year, the swaps market had discounted a year-end target rate of slightly less than 2.65%. Now it is almost 2.25%.
Prices: The broad US dollar sell-off in response to the tariffs, stock market drop, and falling rates, saw the greenback fall to almost CAD1.4025 last week, its lowest level since last December. There was some relief that Canada was not caught up with the reciprocal tariffs. However, the dollar recovered ahead of the weekend, and the Canadian dollar was not helped by a weaker-than-expected jobs report. The greenback was bid to almost CAD1.4255 to post its biggest single day advance of the year (~0.95%) and snap a three-day decline. Nearby resistance may near CAD1.4315-25.
Australia
Drivers: Two factors seem to explain most of the Australian dollar's movement. First, is the broad movement of the dollar. The rolling 30-day correlation between changes in the Australian dollar and the Dollar Index was near 0.75, the most since mid-2024 and double what it was at the end of January, until the market's volatile reaction to the trade-war Second, the changes in the Australian dollar are correlated with the changes in the Canadian dollar (~0.80) and has been fairly steady over the past four months between about 0.65 and 0.85.
Data: Australian economic reports in the coming week are mostly survey data that do not have much impact in any event. The Reserve Bank of New Zealand meets on April 9. It has delivered three consecutive half-point cuts, and its cash target rate stands a 3.75%. The economy was hit hard in the middle two quarters last year, contracting 1.1% quarter-over-quarter in Q2 and Q3. It grew by 0.7% in Q4. New Zealand does not report a monthly CPI and in Q4 24 CPI was 2.2% year-over-year. This would suggest scope for another 50 bp cut but the swaps market says this is unlikely. Still, the year-end target rate is seen near 3.0%, little changed from the end of last year.
Prices: Amid the US dollar's dramatic recovery ahead of the weekend, amid a broad risk-off move, sharp drop in equity markets, and the escalation of the trade war, the Australian dollar was kicked to almost $0.5985, its lowest since early days of the pandemic in 2020. It stabilized but still finished Friday's session down more than 4.2%, the biggest move since the October 2008. The next big chart point is the "Covid-low," in March 2020, near $0.5500. The volatility has seen the Australian dollar traded above its upper Bollinger Band on Thursday, set two standard-deviations on either side of the 20-day moving average, and then before the weekend, it settled almost at four standard-deviations below the 20-day moving average(~$0.6010). This seems exaggerated, perhaps by the triggering of longstanding stop-loss orders. A retest on the bottom of the previous trading range, around $0.6200 seems reasonable.
Mexico
Drivers: The US trade war hits a Mexican economy that is struggling to find traction. It is more insidious as it challenges the very basis of the Mexico's modernization strategy. NAFTA and the USMCA, in a way, broaden the old maquiladora "free-trade zone". The economic weakness and high real policy rate, falling inflation has given the central bank scope to ease policy more aggressively that it did last year. The combination of certainty (what the US has already done) and uncertainty (what is coming next) paralyzes business and investor decisions.
Data: Mexico reports March CPI in the middle of the week. Estimates from the first half of last month, give scope for headline rate to slip from 3.77% in February, while the core rate may be stick 3.6%-3.7%. The overnight target rate is at 9% and the swaps market is discounting nearly 125 bp of cuts over the next six months. February industrial production is due at the end of the week. It has fallen for four consecutive months and in five of the past six. The manufacturing PMI we know fell to 47.6 in February from 49.1 in January. It has not been above 50 since last June.
Prices: The dollar fell from near MXN20.50 on Wednesday and to a low the following day near MXN19.84. But in the greenback's post jobs data bounce, it jumped back to a new high for the week, around MXN20.56 before settling a little above MXN20.44. The dollar rose for the third consecutive week against the peso, and it looks poised to strong going into next week. The next area of resistance may be around MXN20.70, though last month's high was closer to MXN21.00.
Reviewed by Marc Chandler
on
April 05, 2025
Rating:
