Paused and Confused

“I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a 400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.” – James Carville

President Donald Trump announced a 90-day pause on the so-called reciprocal tariffs on most nations, while raising duties on all Chinese imports to 125% from 104%. The abrupt U-turn followed turmoil in financial markets and a sharp bond sell-off. Trump said “The bond market is very tricky…I was watching it. But if you look at it now, it’s beautiful — the bond market right now. But I saw last night where people were getting a little queasy.”

The other US tariffs remain in place. Tariffs on steel, aluminum and automobiles remain at their current rates. The baseline tariff of 10% on goods imports from all trading partners stays. Tariffs of 10% or 25% on Canadian and Mexico goods, with the exception of items covered by the North American trade pact, will also stay the same.

The market reaction to the US tariff pause was swift. The S&P 500 surged 9.5%, 10-year Treasury yields fell almost 20bps to 4.26%, and USD briefly recovered some of its losses.

In our view, relief rallies in risk assets will be short lived and USD will remain under downside pressure. The pervasive uncertainty created by continuously changing US tariff threats and escalating US-China trade war remain a major drag to the global economy. Meanwhile, the abrupt about face on trade policy further erodes the already dwindling credibility of US policymaking.

The FOMC minutes of the March 18-19 meeting showed growing concerns among Fed officials about US stagflation risk. According to the minutes “almost all participants” viewed “risks to inflation as tilted to the upside and risks to employment as tilted to the downside…Several participants emphasized that elevated inflation could prove to be more persistent than expected.” Heightened risk the US falls into stagflation is not USD supportive.

The US March CPI print is the key data release today (1:30pm London). Headline CPI is expected at 2.5% y/y vs. 2.8% in February and core CPI is expected at 3.0% y/y vs. 3.1% in February. Watch-out for super core CPI (core services less housing), a key measure of underlying inflation. In February, super core CPI eased to 3.8% y/y vs. 4.0% in January, the lowest rate since October 2023. Overall, progress on inflation is stalling above the Fed’s 2% goal and risks are skewed to the upside due to increased tariffs. Fed speakers today include: Logan, Schmid, Goolsbee, and Harker.

Interesting insight from the Kiel Institute for the World Economy. According to their model US trade policy primarily harms the US economy. The logic is that the US is turning away from free trade. But there are around 200 other countries still trading under the existing rules.

NORWAY

Norway March CPI print was mixed. Headline inflation slowed more than expected to 2.6% y/y (consensus: 2.9%, Norges Bank forecast: 2.7%) vs. 3.6% in February while underlying inflation remained at 3.4% y/y for a second consecutive month (consensus and Norges Bank forecast: 3.4%). At its March 26 meeting, the Norges Bank kept rates steady at 4.50% and stressed that “a restrictive monetary policy is still needed to bring inflation down to target within a reasonable time horizon.”

However, the swaps market has fully priced-in 75bps of easing over the next 12 months that would see the policy rate bottom near 3.75%. In contrast, the Norges Bank forecasts 50bps of easing by year-end to 4.00%, followed by a gradual decline to 3.00% by the end of 2028. Overall, lower crude oil prices and the unfavorable global growth outlook do not bode well for NOK.

AUSTRALIA

RBA Governor Michele Bullock gives a keynote speech today (11:00am London). Markets will look to see if Bullock pivots away from her cautious policy guidance to an outright dovish stance due to the downside risk to Australia’s economy from the US tariffs. Australia is a small open economy meaning it is heavily reliant on international trade. A dovish pivot would be headwind for AUD.

Cash rate futures have already adjusted sharply lower to imply 125bps of cuts in the next twelve months. Cash rate futures have also fully priced-in a 25bps cut at the next May 20 RBA meeting and about 30% odds of an additional 25bps cut.

CHINA

USD/CNY rallied towards the top-end of the fixing band near 7.3500, the highest since 2007. As a background USD/CNY is allowed to trade within a +/-2% of the fixing. Today, the People’s Bank of China (PBOC) set the USD/CNY fixing at 7.2092 slightly above yesterday’s 7.2066 fixing.

Meanwhile, USD/CNH dropped back towards 7.3480 after hitting an all-time high of 7.4290 on Monday. The PBOC is trying to reign-in CNH depreciation by gradually tweaking the USD/CNY fixing.

China’s economy is struggling to escape a deflationary spiral. In March, headline CPI unexpectedly dipped -0.1% y/y (consensus: 0%) vs. -0.7% in February. Core CPI picked-up but remains subdued at 0.5% y/y vs. -0.1% in February. Finally, PPI contraction extended into a 30th month falling by -2.5% y/y (consensus: -2.3%) vs. -2.2% in February.

To escape the debt-deflation loop, Chinese policymakers need to ramp up fiscal measures to boost consumption. China's consumption-to-GDP ratio is very low at round 40%, due to high household savings, low household income levels, and high levels of household debt.

China's top leaders are meeting today to discuss additional economic stimulus in response to US President Donald Trump's increased tariffs. Yesterday, China confirmed it will impose an 84% tariff on all imports from the US starting today, in response to the US’s 104% tariff on Chinese goods. Trump further escalated duties on China to 125% and said “I don’t think we’ll have to do it [raise tariff] more. We calculated it very carefully.”

In our view, a grand bargain between the US and China to devalue USD versus CNY is still a possibility. Such a deal would hit two goals at once: help US President Donald Trump achieve his core goal to revitalize American manufacturing activity and help rebalance China’s economy away from investment towards consumption.