Labor Market Holds the Key

• The US February non-farm payrolls print will decide whether poor economic activity in January was just a blip or the start of a deeper downturn. Fed Chair Jay Powell speaks later today.
• Canada’s February labor force report will help shape rate expectations ahead of next week’s BOC meeting. Markets price-in over 70% odds of a cut. We expect the BOC to pause easing.
• ECB signaled the bulk of easing is done. EUR/USD trading at highest level since early November.

USD is breaking lower driven by EUR strength. US tariff policy whirlwind and encouraging Eurozone fiscal developments have shifted the relative economic growth dynamic trend in favor of EUR.

US backtracks for a second time this week on tariffs. After hitting Canada and Mexico with 25% tariffs on Tuesday (with a reduced 10% rate for Canadian energy), the Trump administration announced Wednesday that the 25% tariffs on autos and auto parts traded through the United States-Mexico-Canada Agreement (USMCA) would be paused for one month. And on Thursday, the Trump administration delayed tariffs on all goods covered by the USMCA until April 2. In response, Canada postponed imposing counter-tariffs of 25% on C$125 billion worth of US products to April 2 from March 25.

Regardless, other tariffs loom which is expected to have a significant adverse economic impact on Canada and Mexico given their very strong integration and exposure to the US market. 25% tariff on all steel and aluminum imports to the US will go into effect on March 12 and a wider round of “reciprocal” tariffs are due as soon as April 2. USD/CAD and USD/MXN have retraced all the gains triggered by the initial US executive order on February 1 to impose duties on Canada and Mexico.

Fed officials continue to argue for patience. Fed Governor Christopher Waller stressed there’s no need to cut rates at the March 18-19 meeting, but still sees potential for two to three cuts in 2025. Fed funds futures and the FOMC median Dots imply 75bps of easing this year. Meanwhile, Atlanta Fed President Raphael Bostic said “you’ve got to be patient and not want to get too far ahead” because there’s a lot of policy uncertainty. Fed Chair Jay Powell takes the spotlight today as he speaks on the economic outlook and participates in a Q&A session (5:30pm London).

We remain constructive on the US growth outlook but the consumer spending contraction in January is a red flag. Indeed, the Atlanta Fed Q1 GDPNow model is currently tracking at -2.4% SAAR, up from -2.8% on March 3. The strength of the labor market will decide whether poor economic activity in January was just a blip or the start of a deeper downturn.

Today’s February non-farm payrolls data will be key (1:30pm London). Non-farm payrolls are expected at 160k vs. 143k in January, indicative of a healthy labor market. For reference, payroll job gains averaged 237k per month over the past three months with last month's gains likely held back by the Los Angeles wildfires and the harsh winter weather. Fed Governor Waller pointed out that the breakeven pace of job gains needed to keep the unemployment rate stable is between 80k and 100k.

The unemployment rate is projected to be unchanged at 4.0% in February which would track below the Fed’s 2025 projection of 4.3%. Average hourly earnings are forecast at 4.1% y/y vs. 4.1% in January consistent with the Fed’s 2% inflation target given annual non-farm productivity growth of around 2%.

Risks to February non-farm payrolls are skewed to the downside. The February ADP private employment gains undershot expectations and job-cut announcements totaled 172,017 in February, the most since July 2020. The federal government accounted for the largest share of cuts (62,242), reflecting the impact of the Department of Government Efficiency (DOGE) actions. Still, it’s worth noting that total federal jobs account for less than 2% of total non-farm employment.

Bottom line: Lower than expected job gains in February will raise odds of a US economic downturn and further weigh on USD. In contrast, evidence the US labor market remains in solid shape will lead USD to retrace some of its recent sharp losses.

EUROZONE

EUR is outperforming most major currencies underpinned by a less dovish ECB and encouraging Eurozone fiscal developments. As was widely expected, the ECB trimmed yesterday the policy rate 25bps to 2.50%. Importantly, the ECB stressed that “monetary policy is becoming meaningfully less restrictive” suggesting the bulk of easing is done.

Still, the ECB’s updated macroeconomic projections suggests additional policy rate cuts cannot be ruled out. Real GDP growth was marked down in 2025 and 2026 and headline CPI inflation is still expected to average 1.9% over 2026. The swaps market is pricing-in 60% probability of 25bps cut in April.

ECB President Christine Lagarde noted “the decision was a consensus, and no one opposed that decision”, adding only Governor Holzmann abstained. Holzmann is the most hawkish governing council member, so his abstention won’t move the dial on rate cut expectations. Recall, Holzmann was the sole member to oppose the ECB rate cut last June.

Meanwhile, the prospect for looser fiscal policy in the Eurozone lessens the need for the ECB to do the heavy lifting in supporting growth and is EUR positive. This week the European Commission announced plans for an €800bn package (€150bn in borrowing facility and €650bn space within which member states can borrow for defense purposes). Additionally, the German government will present a bill in parliament next week to set up a €500bn fund spread over ten years for infrastructure spending and a special measure to amend the constitution to exempt defense and security outlays from limits on fiscal spending.

CANADA

Canada’s February labor force report (1:30pm London) will help shape rate expectations ahead of next week’s Bank of Canada (BOC) policy setting meeting. Consensus sees a 20k rise in jobs vs. 76k in January, while the unemployment rate is expected at 6.7% vs. 6.6% in January. Overall, the labor market remains soft and firms’ hiring intentions are muted. Markets price-in 80% odds of a 25bps BOC policy rate cut at the March 12 meeting given the drag to growth from tariffs uncertainty. Still, we expect the BoC to pause easing next week because core inflation (average of trim and median CPI) is tracking above the BOC’s Q1 projection of 2.5%.

On Sunday, Liberal Party members will choose a successor to Prime Minister Justin Trudeau. The new leader is expected to face a vote of no confidence once parliament reopens on March 24 which will trigger snap federal elections.

CHINA

China’s February trade data continues to point at weak domestic demand activity. China’s trade surplus rose more than expected by $170.51bn (consensus: $147.50bn) as exports increased 2.3% y/y (consensus: 5.9%) while imports plunged -8.4% y/y (consensus: 1.0%). China cannot rely on exports to sustain a recovery in economic activity and needs to stimulate consumer spending. Net exports are too small to matter.