The market is still torn between trade war becoming real and recession/stagflation looming

Outlook

Real data is due today, including durable goods, jobless claims, pending home sales and a fresh estimate of Q1 GDP that will include personal consumption spending, a clue for PCE inflation on Friday. Q4 GDP was at 2.3% and the newest data is expected to show the slowdown starting.

A slowdown and/or a drop in PCE inflation tomorrow could encourage Fed funds bettors to bring forward their rate cut forecast, now at 80% for June. This is a dollar-negative. Offsetting that is the push the dollar gets from tariff expectations, due to start next week for Canada and Mexico and with Europe now added to the bag yesterday.

Canada and Mexico are fairly powerless, but is Europe a different kettle of fish? The EU is the third largest world economy. 

Yesterday Trump upped his bully bet by naming a 25% tariff on all European imports. So far the screams of outrage are subdued. Something is going on, maybe. Perhaps waiting for the hammer to drop is a tactic while talks go on behind closed doors. Or maybe the EU has a killer response under wraps to release at the right moment. 

In case you are not already confused, the gyrations in the bond market are there to mess up your head. Reuters puts it well: “The bond market senses some trouble, with 10-year Treasury yields sliding to their lowest of the year on Wednesday before steadying and reclaiming 4.3% early today.

“Two-year yields hit their lowest since before November's election on Wednesday but firmed again today to 4.1%.

“The swoon in yields, which have lost about a quarter of a percentage point in just two weeks, has been exaggerated in part by nerves about another debt ceiling standoff ahead - which Federal Reserve officials have indicated may pause its ongoing balance sheet runoff of bonds.”

Forecast

The market is still torn between trade war becoming real (dollar up) and recession/stagflation looming (dollar down). Whether we like it or not, the US stock market is influencing the dollar as a barometer of risk appetite. ECR has a splendid introduction to its ideas about asset allocation:

“The sharp increase in geopolitical uncertainties, a stagnating European economy, and slowing US economic growth could be seen as a brewing storm threatening highly valued US stock prices. However, we believe slowing growth will lead to increased expectations of monetary stimulus, putting upward pressure on asset prices before a potential storm arrives later this year.”

In other words, no bursting bubble just yet but rather a “final bullish phase.” Allocations are still out of equities and into fixed income, but by a few percent, not in droves. An important point—you can have a slowdown without getting a recession.

An important question, maybe the most important—if Trump pulls back on tariffs, especially on Canada and Mexico as would be reasonable, and if the EU can boost the economy through fiscal easing and deregulation, the dollar stops falling.

The report is comprehensive, detailed and sane. 

Tidbit: We await PCE and core PCE on Friday, Feb 28. The last reading was 2.8% y/y with the forecast for Friday at 2.6%. But as we showed earlier this week, some components are really, really bad, like shelter up 7.9% y/y in Jan, with food up 10.1% and the overall net up 6.4% due to the drop in energy. A little perversely, with recession now at the top of everyone’s mind, a drop in inflation can be interpreted as falling demand, regardless of what supply is doing.

The unsettling bottom line is that a good number of Friday (like a drop from 2.8% to 2.6%) can be interpreted as “bad” because of stocking up ahead of time, while a rise (such as 2.8% to 3.0%) is also bad because it means the Fed can’t really say inflation is being tamed enough to justify a cut.

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This is an excerpt from “The Rockefeller Morning Briefing,” which is far larger (about 10 pages). The Briefing has been published every day for over 25 years and represents experienced analysis and insight. The report offers deep background and is not intended to guide FX trading. Rockefeller produces other reports (in spot and futures) for trading purposes.

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