Happy Days
USD is mixed near recent lows. Cyclical sensitive currencies are outperforming while safe haven one’s are underperforming reflecting the recovery in global equity markets. Financial market risk sentiment improved after US President Donald Trump suggested he might temporarily exempt the auto industry from the 25% tariffs he previously imposed on the sector.
At the same time, the Trump administration pressed forward with plans to impose tariffs on semiconductor and pharmaceutical imports after the Commerce Department initiated trade probes yesterday. Bottom line: relief rallies in risk assets should prove fleeting because the ongoing trade war is a major blow to global economic activity.
Fed Governor Christopher Waller outlined two tariff scenarios for the US economy. In the “large tariff” scenario, inflation would peak near 5% in coming months, the economy would slow significantly later this year and the unemployment rate would rise from 4.2% to 5% next year. In this scenario “bad news” rate cuts are likely as “the risk of recession would outweigh the risk of escalating inflation, especially if the effects of tariffs in raising inflation are expected to be short lived.”
In the “smaller tariff” scenario, inflation would peak near 3% and the negative effect on output and employment growth would be smaller than the larger tariff scenario. In this case “good news” rate cuts are very much on the table in the latter half of this year Waller said. In our view, the large tariff scenario would be the most negative for USD as it could lead to negative US real yields.
US Treasury Secretary Scott Bessent downplayed last week’s US bond market chaos. Bessent reiterated his administration’s strong-dollar policy and noted he sees no evidence of sovereign sales of Treasuries. However, the simultaneous sell-off in Treasuries and dollar decline suggests some unwinding in foreign holding of Treasuries. We’ll have to wait for the April US Treasury International Capital (TIC) data due June 18 to gage the extent of sovereign selling of Treasuries.
EUROZONE
EUR/USD is consolidating just under 1.1400. The ECB’s bank lending survey for Q1/Q2 (9:00am London) and April German ZEW investor economic sentiment survey (10:00am London) are today’s domestic highlights. In March, the ZEW expectations index improved more than expected to a three-year high at 51.6 (consensus: 48.3) vs. 26.0 in February, consistent with a solid recovery in Eurozone economic activity. However, the Eurozone economy faces downside risk from the ongoing trade war. As such, the ECB is expected to cut the policy rate 25bps to 2.25% Thursday.
UK
GBP is up versus USD and EUR. The UK February labor market data was mixed and supports the case for a Bank of England (BOE) policy rate cut at the next May 8 meeting. The unemployment rate printed at 4.4% for a fourth consecutive month in February and is tracking below the BOE’s Q1 projection of 4.5%. Total regular pay was 5.9% y/y vs. 5.8% in January (revised down from 5.9%), and the policy-relevant private sector regular pay was 5.9% y/y (consensus: 6.0%, BOE projection: 6.2%) vs. 5.9% in January (revised down from 6.1%).
Leading indicators point to a softer jobs market. In March, the KPMG/REC permanent placement index remained in contraction territory for a 30th month in a row, and its gauge of staff availability rose the most since December 2020. Meanwhile, the BOE’s Decision Maker Panel (DMP) survey shows business expect year-ahead annual wage growth of 3.9%. The BOE is expected to cut the policy rate by 25bps to 4.25% in May.
AUSTRALIA
AUD/USD is up near key resistance at 0.6400 (February-April triple top). RBA Minutes of April Policy meeting indicated that the next policy rate decision on May 20 will be live. “Members observed that the May meeting would be an opportune time to revisit the monetary policy setting with the benefit of additional data about inflation, wages, the labour market and trends in economic activity, along with a fresh set of economic forecasts and further information about the likely evolution of global trade policies. Collectively, this information would have a considerable bearing on their decision.” Cash rate futures have also fully priced-in a 25bps cut in May and 34% odds of an additional 25bps cut.
CANADA
USD/CAD is trading heavy around 1.3860 on broad USD weakness. Canada’s March CPI print (1:30pm London) will help shape Wednesday’s Bank of Canada (BOC) policy rate decision. Headline inflation is expected at 2.7% y/y vs. 2.6% in February while core inflation (average of trim and median CPI) is anticipated at 2.95% y/y vs. 2.9% in February. The end of the sales taxes break in mid-February is expected to keep upside pressure on prices. Nevertheless, longer-term inflation expectations remain well anchored around 2%.
The BOC is expected to keep rates steady at 2.75% tomorrow but the decision is finely balanced. The swaps market price-in 34% odds of a 25bps cut while 13 of the 30 analysts polled by Bloomberg have a 25bps cut penciled-in. In our view, the BOC has room to ease policy further because the trade war risk pushing Canada’s economy into recession. The labor market has already taken a hit as Canada unexpectedly lost almost 33k jobs in March and business hiring intentions are weak.
The BOC’s April Monetary Policy Report will include updated macroeconomic projections and a revised estimate of the neutral rate. The BOC currently estimates a neutral rate range between 2.25% to 3.25%. Unless the trade dispute is fully resolved, the BOC has room to gradual bring down the policy rate below neutral settings. The swaps markets imply 50bps of total easing over next 12 months that should see the policy rate bottom at 2.25%.
