Markets currently fear upside inflation risks from the tariff treats

Markets

Mexico and Canada dodged the US tariff bullet at the very last moment. At least for now. Tariffs will be paused for a 30 day period to see whether or not a final deal can be structured with both countries over border control and the fentanyl crisis. Canadian PM Trudeau is pushing through with its C$1.3bn border-control plan announced in December and appointed a “fentanyl czar”. US President Trump was less forgiving towards China where 10% additional tariff takes effect and immediately prompted retaliation. China will levy tax on some products, eg targeting the farming and energy sector while probing Google over alleged anti-trust law breaches. We fear that Trump’s unpredictable reaction function and good-cop, bad-cop approach is hurting risk sentiment more and more with an asymmetric response: selling off on bad news and not completely recovery on positive elements. Today’s trading session could be a point in case. European and US equity futures currently hand in gains (triggered by the after market decision on Canada) for losses after this morning’s escalation with China. The tariff-related volatility is far from over with loudmouthing against the EU undoubtedly to morph into specific (verbal) threats soon. EUR/USD in the same vein rebounded from the low 1.02-area on Monday morning towards 1.0350 (just below Friday’s close), but the pair is being taken back below 1.03 this morning. The US Treasury yield curve bear flattened yesterday with daily yield changes ranging between +5.1 bps (2-yr) to +0.4 bps (30-yr). Markets currently fear upside inflation risks from the tariff treats more than they do downside growth risks. First Fed comments tended to confirm this with the likes of Chicago Fed Goolsbee saying that Trump policies could slow the Fed’s cutting cycle and Atlanta Fed Bostic also inclined to wait a while before a next move. Boston Fed Collins would try to look through the impact of tariffs if inflation expectations stay anchored, but she’s equally not in a hurry to make additional policy rate adjustments. The US manufacturing ISM’s first 50+ reading since October 2022 failed to make it to the headlines, but also strengthens the pause card. Details showed production output rising again (52.5) on the back of a significant rise in new orders (55.1) and new export orders (52.4) with companies going back to hiring (50.3). Manufacturers have been running down their inventories for over two years and seem to become more sensitive to rising demand. On the inflation side, priced paid accelerated from 52.5 to 54.9. Higher-than-expected EMU January CPI (2.5% Y/Y headline and 2.7% Y/Y core) went unnoticed but marks a contrast with yesterday’s Pavlov reaction that US tariffs would be buffered by easier monetary policies outside of the US.

News and views

French prime minister Bayrou pushed through his 2025 budget bill in parliament yesterday using Article 49.3 to avoid a vote. He did so because his government lacks a majority. Meanwhile France is relying on emergency legislation to avoid a state shutdown until a full annual budget is adopted. Bayrou’s predecessor, Barnier, pulled the same move late last year, triggering a vote of no-confidence that ultimately ended up in a collapse of the minority government. The far-left La France Insoumise in response to Bayrou already said it will table such a motion once again. A vote is likely to happen already today. But unlike Barnier, Bayrou is expected to survive due to some concessions he made to the Socialists including preserving spending for healthcare, education and pensions. In turn, the latter will not support the motion. Bayrou is targeting a smaller fiscal consolidation than his predecessor, with a €50bn saving effort (compared to Barnier €60bn) aimed to reduce the deficit to 5.4% of GDP this year. French OATs outperformed both the periphery and Bunds vs. swap yesterday.

The Bank of International Settlements pressed the likes of the Fed and ECB to revamp the way they approach interest rate setting, more specifically to avoid the mistakes made (of waiting too long to raise rates) in the wake of the pandemic. Outgoing BIS chief Carstens said "The post-pandemic experience calls for rebalancing the frameworks towards the risks posed by inflation surges”. He is more a fan of scenario analyses rather than the current forward guidance approach. Carstens said that while central banks still need to “respond forcefully” when rates are at or near zero if required, they also should use “decisive monetary tightening” when inflation rebounds. The merits of makeup strategies – compensate inflation undershoots with overshoots – should be reconsidered, he added. Both the Fed and ECB are currently conducting a strategic review with the results expected around the middle of the year.

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