Markets Caught in a Tariff Trap and Can’t Walk Out

• US tariff announcements triggered a bout of risk aversion. USD if firmer and global equity markets are selling off.
• The US January PCE takes the spotlight today. Weak spending and sticky inflation are risks to the US macro backdrop.
• Tokyo CPI inflation cools more than anticipated in February. Bank of Japan unlikely to crank-up pace of rate hikes.

US tariff announcements triggered a bout of risk aversion. USD if firmer against most currencies, Treasuries extended gains across the curve, and global equity markets are selling off. US President Donald Trump announced yesterday that the 25% tariffs on Canada and Mexico (with a reduced 10% rate for Canadian energy) would come into force from March 4 as previously planned.

Also, tariffs on Chinese imports would double to 20% effective March 4. A spokesperson for the Chinese Ministry of Commerce warned today “if the US insists on having its own way, China will counter with all necessary measures to defend its legitimate rights and interests.”

Fed officials stick to the “no hurry to resume easing” script. Cleveland Fed President Beth Hammack (2026 FOMC voter) stressed “I believe that monetary policy has the luxury of being patient as we assess the path forward, and this will likely mean holding the federal funds rate steady for some time.” Kansas City Fed President Jeff Schmid (FOMC voter) pointed out that “with inflation just recently at a 40-year high, now is not the time to let down our guard.”

Nevertheless, concerns over the US growth outlook curtails near-term USD upside potential and supports the rally in Treasuries. Today’s January US PCE data (1:30pm London) could confirm the poor retail sales and hot CPI prints already reported.

The policy-relevant headline PCE is expected at 2.5% y/y vs. 2.6% in December and core PCE is projected at 2.6% y/y vs. 2.8% in December. The Cleveland Fed’s inflation Nowcast model estimates headline and core PCE at 2.5% and 2.7%, respectively. Overall, progress on inflation is stalling well above 2% and suggests the bar for additional Fed funds rate cuts is high.

Personal spending is expected at 0.2% m/m vs. 0.7% in December, and real personal spending is forecast at -0.1% m/m vs. 0.4% in December. Recall, the retail sales control group unexpectedly plunged -0.8% m/m in January after rising 0.8% in December. For reference, PCE is a more comprehensive measure of consumer spending as it includes purchases of goods and services and is reported in real terms. Retail sales only tracks nominal spending for goods.

Philadelphia Fed President Patrick Harker, who retires at the end of June, struck a cautious tone on the US consumer spending outlook. Harker cautioned that the credit card borrowing data “clearly tell us that many consumers are under stress in managing their finances… This is not necessarily a flashing red light to me, but a yellow one.”

UK

The US and UK are in talks on a trade deal that could spare the UK from tariffs. Trump said “I think we could very well end up with a real trade deal where the tariffs wouldn’t be necessary.” This isn’t surprising as the UK is one of the few countries where the US runs a trade surplus in goods and services. Meanwhile, UK-EU trade relations are warming up and could lead to a more favorable UK business investment outlook. Bottom line: closer US-UK and EU-UK ties bodes well for GBP versus EUR.

EUROZONE

EUR/USD is heavy around 1.0400. The ECB Account of the January 29-30 meeting reinforce the case that more easing is in the pipeline. According to the Account “as long as the disinflation process remained on track, policy rates could be brought further towards a neutral level to avoid unnecessarily holding back the economy.” ECB staff estimate the neutral rate at 1.75%-2.25%. The ECB policy rate is currently at 2.75%.

The ECB January Consumer Expectations Survey is expected to show that long-term inflation expectations are well anchored around 2% (9:00am London). 3-year expectations are projected at 2.5% vs. 2.4% in December. 1-year expectations are forecast to remain at 2.8% for a second consecutive month.

Germany’s preliminary February EU harmonized CPI (1:00pm London) will offer a preview of next week’s Eurozone February CPI print. German CPI is expected at 2.7% y/y vs. 2.8% in January. Spain’s EU harmonized CPI matched consensus at 2.9% vs. 2.9% in January while France EU harmonized CPI undershot consensus by 0.2pts to 0.9% y/y vs. 1.8% in January.

Bottom line: the ECB has scope to deliver on rate cut expectation. Interest rate futures have fully priced-in 75bps of ECB easing over next 12 months and the policy rate to bottom around 2.00%. The prospect of more ECB easing remains a major headwind for EUR.

JAPAN

USD/JPY rallied above 150.00. Tokyo February CPI inflation cools more than anticipated and supports the case for a gradual Bank of Japan (BOJ) normalization cycle. Headline CPI and core ex-fresh food inflation eased to 2.9% y/y (consensus: 3.2%, prior: 3.4%) and 2.2% y/y (consensus: 2.3%, prior: 2.5%). Core ex-fresh food and energy remained at 1.9% y/y (consensus: 2.0%, prior: 1.9%). The market continues to imply about 50bps of BOJ policy rate hikes over the next two years to 1.00% which limits JPY upside.

CANADA

USD/CAD surged almost 1% as US tariff threat raised Bank of Canada (BOC) rate cut bets. Markets price-in over 50% odds of a 25bps BOC policy rate cut in March and a total of 60bps of easing over the next 12 months vs. 40bps earlier this week. We expect the BoC to pause easing at its next March 12 meeting in part because core inflation (average of trim and median CPI) is tracking above the BOC’s Q1 projection of 2.5%.

Canada monthly and quarterly GDP data are due today (1:30pm London). Statistics Canada advance information indicates that real GDP by industry increased 0.2% m/m after falling -0.2% in November. The January GDP estimate will be published at the same time. Over Q4, the Bank of Canada (BOC) projects real GDP by expenditure at 1.8% SAAR vs. 1.0% in Q3 driven by consumer spending, residential investment, and net exports. Business investment is expected to remain subdued while inventory destocking is forecast to be the main drag to growth in Q4.