The dollar is broadly weaker as reciprocal tariffs went into effect at midnight. DXY is trading lower for the second straight day near 102.351 as the dollar is no longer seeing any benefits from either higher yields or tariffs (see below). The yen and Swiss franc continue to outperform, with USD/JPY trading lower near 145 and EUR/CHF trading lower near 0.92745. Elsewhere, both the euro and sterling are trading higher near $1.1030 and $1.2815, respectively. Regardless of where the dollar eventually lands, we expect the growth-sensitive majors and EM FX to remain under pressure as risks to global growth pile up. We continue to believe that some of the post-tariff dollar weakness is due to a growing loss of confidence in U.S. policymakers and so we view any dollar recoveries as quite fragile, no matter how the U.S. data come in. We continue to downplay any notions of a Fed rescue and so risk off impulses are likely to continue hitting global markets from time to time.
AMERICAS
The reciprocal tariffs went into effect at midnight. Those on China were especially steep; the grand total was 104%, consisting of the 20% initial tariff, the 34% reciprocal tariff, and the new 50% punitive tariffs. China won't bend the knee and so it may retaliate again and set off another cycle of tit-for-tat moves. We continue to emphasize that we really have to watch what China, the U.S., and the EU do. Major countries like the UK and Japan are only a small share of global GDP, whereas the Big Three account for nearly 60%. We expect the EU to announce a package of retaliatory tariffs in the coming days after the U.S. rejected its recent offer of zero tariffs on bilateral trade in industrial goods.
U.S. Treasuries are selling off at the long end. We’ve noted before that recent dollar weakness runs contrary to its typical role as a safe haven. Indeed, today’s weakness also means that tariffs are no longer giving the greenback any support as they had in the past. USTs had held up but have now been caught up in the selling pressures, with the 10-year yield jumping from a cycle low of 3.86% last Friday to a high of 4.51% earlier today. It’s possible that this move is due to a crisis of confidence. However, the jump in U.S. yields this week may largely be due to a growing unwind of the so-called basis trade that is causing some forced selling. We saw a similar episode during the early days of the pandemic. This rare bout of synchronized selling of US assets may indeed reflect a broad loss of confidence in the U.S. due to the unravelling of the trade network and alliances that sustains U.S. financial leadership. However, other factors may be magnifying these moves and so we may not know for sure for quite some time. Stay tuned.
FOMC minutes will be the highlight. At that March 18-19 meeting, the Fed kept rates on hold for the second straight time and this decision was unanimous. Recall that the FOMC statement was tweaked to reflect elevated levels of uncertainty. First, the statement cautioned that “uncertainty around the economic outlook has increased.” Second, the statement scrapped previous reference that “the risks to achieving its employment and inflation goals are roughly in balance.” The updated Dot Plots were unchanged, but the details were skewed in favor of less easing. The updated economic projections painted an unfavorable picture, with growth forecasts cut and inflation forecasts raised. According to Powell “a good part” of the marked-up inflation comes from the effects of tariffs, adding that tariffs “tend to bring growth down and they tend to bring inflation up.” Still, Powell noted that his “base case” is that the inflationary effect from tariffs will be transitory. That will surely be tested.
The Fed also announced it was slowing the unwind in Treasury holdings starting April 1. This was presented as a technical adjustment to ensure reserves remain abundant in the runup to yet another debt ceiling showdown. The Fed will allow up to $5 bln (down from $25 bln) in UST and $35 bln (unchanged) in MBS to roll off its balance sheet each month without reinvestment of principal. Only Governor Waller voted against this action and preferred to continue the previous pace of decline in securities holdings. With reserves actually rising, we agree with Waller and saw no need to slow QT.
Fed officials are still maintaining the wait and see approach. Daly said “We cut the interest rate by 100 bp last year. That puts policy in a good place to stay modestly restrictive - keep inflation coming down - but not so restrictive that the economy is vulnerable. So, with growth good and policy in a good place, we’ve built the time and the ability to just tread slowly and tread carefully.” We continue to downplay any notions of a Fed put. Still, odds of a May cut have risen back to 55%, while the swaps market is pricing in 100-125 bp of total easing over the next 12 months. Barkin speaks today.
The growth outlook is getting murkier. The New York Fed Nowcast model now estimates Q1 growth at 2.6% SAAR vs. 2.9% the previous week and Q2 growth at 2.4% SAAR vs. 2.6% the previous week. This still greatly contrasts this with the Atlanta Fed GDPNow model, which estimates Q1 at -2.8% SAAR and will be updated today after the February wholesale inventories and trade sales data. Q1 has drawn to a close but we won’t get official GDP data until April 30.
EUROPE/MIDDLE EAST/AFRICA
ECB officials are acknowledging the downside risks from U.S. tariffs. GC member Villeroy said “The changes since April 2 indeed make the case for a cut soon.” Elsewhere, GC member Rehn said that that “the grounds for continuing rate cuts in the April meeting have grown clearly stronger based on a holistic assessment of inflation and the economic growth.” We expect the ECB to deliver a 25 bp cut to 2.25% at the April 17 meeting, which is now fully priced in. The swaps market is now pricing in 75-100 bp of total easing over the next 12 months. Centeno and Cipollone speak later today.
Bank of England officials are acknowledging the impact of U.S. tariffs. MPC member Lombardelli said “We know the tariffs are likely to depress activity overall. The direction there is relatively clear. On inflation, it depends a lot more on the circumstances of actually how other countries respond.” She added that “We’ll think about all of that together for our next decision in May. I’m not going to take a position now.” Indeed, BOE easing expectations have picked up. The market has fully priced in a 25 bp cut to 4.25% at the next meeting May 8, along with nearly 100 bp of total easing over the next 12 months.
ASIA
Bank of Japan Governor Ueda remains cautious. He reiterated the bank’s guidance that it would continue to raise the policy interest rate if the outlook for economic activity and prices is realized. However, he stressed “we need to be very cautious about growing uncertainty surrounding the future development of trade policies in each country.” After an emergency meeting of officials from the Ministry of Finance, Financial Services Agency, and the BOJ (the first since August), Japan’s top FX official Mimura said “We’ll continue to monitor market movements with a high sense of urgency.” The swaps market is no longer pricing in material odds of additional BOJ rate hikes over the next 12 months. Despite this repricing, JPY continues to gain from save haven flows.
Reserve Bank of New Zealand cut rates 25 bp to 3.5%, as expected. The bank noted that “The recently announced increases in global trade barriers weaken the outlook for global economic activity. On balance, these developments create downside risks to the outlook for economic activity and inflation in New Zealand. As the extent and effect of tariff policies become clearer, the Committee has scope to lower the OCR further as appropriate.” There was no press conference. Updated macro forecasts and expected rate path will come at the next meeting May 28. Another 25 bp cut to 3.25% is priced in and there are risks that the bank lowers the expected floor from 3.0% currently. The dovish forward guidance has led markets to price in a terminal rate of 2.5% now vs. 2.75% at the start of this week.
China is pushing back a bit against greater yuan weakness. After USD/CNH surged yesterday, the PBOC moved its daily fix marginally to 7.2066 vs. 7.2038 yesterday. While the fix remained above the 7.20 level for the first time since September 2023, the modest change today suggests policymakers do not want large, disruptive moves in the exchange rate. Elsewhere, we take issue with the notion that China may weaponize its $761 bln stash of Treasuries in a trade war with the U.S. After years of steady erosion, China now holds less than 5% of the total outstanding amount of long-term Treasury securities. This is too small to have a meaningful impact on Treasury yields.
Reserve Bank of India cut rates 25 bp to 6.00%, as expected. The decision was unanimous. Moreover, RBI changed the policy stance from neutral to accommodative, implying more cuts are in the pipeline. Indeed, Governor Malhotra said “Going forward, absent any shocks, the MPC is considering only two options: status quo or rate cut. The domestic growth-inflation trajectory demands monetary policy to be growth-supportive, while being watchful on the inflation front.” The swaps market is pricing in 50 bp of further easing over the next 12 months that would see the policy rate bottom near 5.50%.
