Dollar Soft as Markets Shrug Off More Tariff Threats

January 22, 2025

Win Thin

Markets continue to be buffeted by contradictory tariff noise; the Fed media blackout is in place until Chair Powell’s post-decision press conference January 29; Canada’s disinflationary process remains intact
The ECB remains in easing mode; sterling and gilts face renewed downside pressure due to the deteriorating U.K. fiscal prospects; South Africa reported soft December CPI data
New Zealand reported mixed Q4 CPI data; Malaysia kept rates steady at 3.0%, as expected

The dollar Is trading softer despite more tariff threats. Trump’s latest tariff threats on China and the EU are being shrugged off (see below). DXY traded today at the lowest since December 30 near 107.749 and a break below 107.237 sets up a test of the December low near 105.420. USD/JPY is trading higher near 155.85 after trading below 155 yesterday. Sterling is trading flat near $1.2255 despite poor PSNB data (see below), while the euro is trading higher near $1.0440 despite dovish ECB comments (see below). More and more tariff noise is likely in the coming days and weeks but we continue to look through that and focus on the underlying fundamental backdrop, which remains unchanged. Simply put, the strong U.S. fundamental story of strong growth, elevated inflation, and a more hawkish Fed continues to favor higher U.S. yields and a stronger dollar.

AMERICAS

Markets continue to be buffeted by contradictory tariff noise. President Trump said late yesterday that “We’re talking about a tariff of 10% on China, based on the fact that they’re sending fentanyl to Mexico and Canada.” This comes right after earlier reports suggesting Trump would not enact immediate tariffs on China and would instead study the situation before acting. For good measure, Trump added that “Other countries are big abusers also, you know it’s not just China,” Trump said. “We have a $350 bln deficit with the European Union. They treat us very very badly, so they’re going to be in for tariffs.” We’ve said it before and we’ll say it again: trading on this tariff noise is a fool’s errand. Look through the noise to see that the underlying strong dollar story based on U.S. economic exceptionalism remains intact regardless of the final tariff plans.

The Fed media blackout is in place until Chair Powell’s post-decision press conference January 29. Despite some mixed signals from officials last week, the market sees the next and only rate cut coming in July. Of course, it will all depend on the data but given the strong momentum in the economy, we agree with the market see steady rates in H1. The only U.S. data today is December leading index and it is expected at -0.1% m/m vs. 0.3% in November.

Canada’s disinflationary process remains intact. December headline inflation unexpectedly dipped to 1.8% vs. 1.9% expected and actual in November, while core (average of trim and median CPI) matched consensus at 2.45% y/y vs. 2.6% in November. Core inflation is tracking a little higher than the BOC’s Q4 projection of 2.3%, suggesting the BOC will likely slow the pace of easing following two consecutive 50 bp cuts. The market sees nearly 85% odds of a 25 bp cut to 3.0% at the January 29 meeting. Bottom line: FED/BOC policy divergence and the risk of all-out trade war between Canada and the U.S. favor a higher USD/CAD.

EUROPE/MIDDLE EAST/AFRICA

The European Central Bank remains in easing mode. Governing Council member Knot signaled alignment with market expectation rate cuts in January and March. However, Knot also echoed comments from other ECB policymakers warning “I’m not convinced yet that we need to go into stimulative mode”, which is estimated to be below 2%. Markets seem to agree and are pricing in 100 bp of total easing over next 12 months that would see the policy rate bottom at 2%. Given how poor the eurozone outlook remains, we remains puzzled as to why policymakers and markets are convinced that the ECB doesn’t need to go below neutral. That said, ECB/Fed policy divergence is an ongoing drag for EUR/USD. Rehn, Makhlouf, Lagarde, and Nagel speak later today.

Sterling and gilts face renewed downside pressure due to the deteriorating U.K. fiscal prospects. The budget deficit rose to -GBP17.8 bln in December vs. -GBP14.2 bln expected and a revised GBP11.8 bln (was GBP11.2 bln) in November. This was the highest December borrowing since the pandemic. Moreover, public sector borrowing for the 2024-2025 financial year is so far tracking GBP4.1 bln higher than what the Office for Budget Responsibility forecast in October. The clear implication is the government may have to announce tax hikes and/or spending cuts when it publishes its Spring economic and fiscal forecast on March 26, further dampening economic activity.

South Africa reported soft December CPI data. Headline came in two ticks lower than expected at 3.0% y/y vs. 2.9% in November, while core came in two ticks lower than expected at 3.6% y/y vs. 3.7% in November. Headline accelerated for the second straight month but remains at the bottom of the 3-6% target range. At the last meeting November 21, the South African Reserve Bank cut rates 25 bp to 7.75% and Governor Kganyago said, “As a central bank in a small, open economy, caution is what’s going to be at play here.” Its model also adjusted the expected rate path high, with the end-2025 policy rate seen at 7.40% vs. 7.17% previously, end-2026 at 7.27% vs. 7.09% previously, and end-2027 at 7.28%. The swaps market agrees and sees the policy rate bottoming at 7.25%. Next meeting is January 30 and another 25 bp cut to 7.5% seems likely.

ASIA

New Zealand reported mixed Q4 CPI data. Headline came in a tick higher than expected at 2.2% y/y and was steady from Q3. Tradeable came in at -1.1% y/y vs. -1.6% in Q3 while non-tradeable came in at 4.5% y/y vs 5.0% in Q3. The RBNZ’s sectoral factor measure for core declined two ticks to 3.1%, the lowest since Q2 2021. When all is said and done, however, headline is converging towards the 2% target mid-point and core is moving towards the 1-3% target range. The RBNZ has penciled in another 50 bp cut to 3.75% in February but warned of a slower pace of easing after that, adding it does not forecast to slash the policy rate below neutral (around 3%) through 2027. The markets agree and see the policy rate bottoming near 3.25% over the next 12 months.

Bank Negara kept rates steady at 3.0%, as expected. The bank suggested again that cuts are not in the pipeline just yet as the policy statement noted that “The monetary policy stance remains supportive of the economy and is consistent with the current assessment of inflation and growth prospects.” The bank also highlighted that “the strength in economic activity is expected to be sustained in 2025” while “inflation is expected to remain manageable.” Ahead of the decision, Malaysia reported soft December CPI data. Headline came in a tick lower than expected at 1.7% y/y. While the bank does not have an explicit inflation target, low price pressures should allow it to ease this year if the economy slows. The swaps market is pricing in 25 bp of easing over the next 12 months.

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