The week ahead: Tariffs, the Bank of England and Nonfarm Payrolls

February is starting with a bang, after Trump fulfilled his threats and signed into law a round of tariffs that has sent the dollar flying and could sour risk appetite after a strong month for stocks in January. A swift sell off in stocks could be on the cards at the start of this week, as investors assess what Trump’s moves mean for corporate margins and global economic prospects. However, there could be a silver lining at the end of the week. The Bank of England is expected to cut interest rates, and the US NFP report for January is expected to report a sharp slowdown in job creation. Below, we look closely at these three themes and share what we think this means for financial markets.

1. Trump’s first shot in a new global trade war, sees instant retaliation

As we start a new month, the focus is on the tariffs that President Trump signed on Sunday evening, with 25% being levied against imports from Canada and Mexico, and 10% for imports from China. Canada has already imposed retaliatory tariffs on the US, China and Mexico have threated countermeasures against the US. Trump signaled that the EU will be next and, Brussels said that it would ‘respond firmly’ if Trump imposed tariffs on EU goods.

The US tariffs had been well signaled ahead of this, what we didn’t know before Sunday was the extent of retaliatory tariffs against the US. Canada has hit back strongly. Tariffs on $30bn of US goods will come into force on Tuesday, including health and cosmetic products, domestic appliances, pulp and paper, household items, plastics and tires. There is some speculation that Canada has deliberately targeted imports from Republican states who voted for Trump. In a few weeks we will have to see if they extend their retaliatory tariffs to Democratic states, when they are expected to impose tariffs on a further $125bn of US imports.

Trump’s call is crucial

Trump is planning phone calls with Canada and Mexico today. This may give some hope that a deal could be worked out, if not now, then for the future. Interestingly, gold, which has acted as a hedge against tariffs, declined early on Monday. Although it is clawing back some early losses, it is still lower by $11 dollar per ounce. Was the market expecting worse? Or is the prospect of a call keeping traders optimistic?

It's too early to know exactly what impact tariffs will have on the global economy, but it is fair to say that they have a high potential of triggering inflation, and weighing heavily on global growth, including the US economy. President Trump’s objectives include rebuilding the US’s manufacturing base, shrinking the US deficit and generating revenue for the government that could support a corporate tax cut. These aims all look poised to fail. In President Trump’s first term, tariffs triggered a rally in the dollar, which hurt US exports, and manufacturing jobs have been in decline in recent years. History tell us that the kernel of the problem with tariffs is that it raises the cost of living, and it provides life support for less productive companies that otherwise would not exist. AT this stage in the global trade war, the future looks bleak for the US economy and for elsewhere.

Stocks slide as global economic uncertainty increases

Stock markets are likely to have a strong reaction to this news. Asian stocks are broadly lower, with large declines for the Japanese Nikkei, which is lower by more than 2% on Monday, China’s indices are also lower. US stocks are obviously at risk due to their high valuations, and futures for the S&P 500 are lower by more than 100 points. US stocks have lagged European stock market gains in January, now that the EU is in Trump’s firing line for tariffs, European stocks are expected to open sharply lower, and we expect the most severe declines for cyclical stocks and for the big exporters. Service-based economies could prove resilient, after Trump said that a deal can be worked out with UK PM Kier Starmer. Not only is the UK a defensive-style index, especially the FTSE 100, but it is not facing an immediate threat of tariffs, even so the FTSE 100 is still pointing to a 0.8% decline at the start of this week. This does not mean that the UK economy will avoid impact from the tariffs, but it does mean that the UK economy could be more resilient than elsewhere, and the FTSE 100 could outperform its peers at the start of this week. It is also worth noting that Bitcoin and other cryptocurrencies are following stocks lower on Monday, Bitcoin is down $3,100 at the time of writing, as it falls in unison with stocks.

Tariffs: Learning from history

The last time that Trump employed tariffs was in 2018. Back then, tariffs on steel and other primary imports caused global profit margins to shrink, with 12-month operating margin estimates falling to the tune of 50+ basis points, for both US and global companies. This time the impact could be worse. US tariffs are broader based, and Trump seems relentless in his pursuit of narrowing the US’s trade deficit with the rest of the world.

The aggregate blended net profit margin of the S&P 500 at this stage of Q4 earnings season is 12.1%, which is higher than a year ago and is above the 5-year average at 11.6%, according to FactSet. This is worrying for two reasons, firstly, it means that companies have already been passing on cost increases to their customers for years now, and there may be limited scope for consumers to absorb more cost increases caused by tariffs. Secondly, analysts expect net profit margins to improve through to mid-2025. However, with a trade war now a reality, and so many US companies leveraged to the global economy and supply chain, there is likely to be a wave of downgrades for future earnings reports, including net profit margin. This could be a double whammy, which weighs on stock prices for the long term.

Added to this, we doubt that many companies will be able to avoid the impact of tariffs. The surge in the dollar could hurt US multinationals, who convert foreign income into dollars when they report their earnings. At this stage, it is hard to see if anyone will be a winner from this latest move by Trump.

FX: Surge in demand for the Dollar as tariffs become reality

The immediate market impact late on Sunday was a sharp move higher in the US dollar. EUR/USD fell below $1.02 at one stage but has since recouped losses and is back above this level. The Mexican peso initially fell 2% at the open, USD/MXN rose to its highest level since 2020, which is a fairly modest early reaction considering how negative these tariffs could be for the Mexican economy. The Canadian Loonie also suffered a sharp selloff and fell to its lowest level since 2003. The pound has fallen sharply, and is back below $1.23, after trading as high as $1.24 on Friday. The yen attracted some safe haven flows early on, but has since given back gains, while the Swissie is likely too close to Europe to benefit from haven flows at this stage. We expect the Chinese renminbi to also struggle on Monday, however, Beijing is likely to step in to stabilize the currency after the Chinese New Year holiday. Interestingly, a weak currency is no bad thing in a trade war, since it can mitigate some of the effects from tariffs, as exports elsewhere get cheaper. However, a weaker currency is also inflationary, which highlights how the impact of tariffs can be swings and roundabouts.

Crossing the Rubicon

While the tariffs were well signaled, their actual implementation, and the retaliatory tariffs that followed, felt like crossing the Rubicon, especially since tariffs are notoriously hard to reverse once they are put in place.

We will be monitoring markets all day to see how they respond. We expect a broad-based response, and the US is also at risk. Some sectors will be directly exposed to Trump’s tariffs: Grocers may decline since Canada is a big exporter of cherry tomatoes to the US, while Mexico exports avocados to the US, and these will now be hit by tariffs. We expect Apple’s share price to decline, along with other smart phone makers, since many of their components are made in China. Trump’s first term tariffs included an exemption for smart phones, which is not the case this time, which means anyone looking to upgrade their phone in the next few months will likely face a higher bill.

The inflationary impact: Has Trump knocked chances of Fed rate cuts?

Some analysts think that PCE inflation in the US could top more than 3% as a direct result of the tariffs. This could mean higher prices for everything from oil, groceries to cars, which might limit the Fed’s ability to maneuver when it comes to interest rates. No doubt, the law of unintended consequences will also come into play, with the possibility of much confusion as businesses get used to new tariffs. Long delays of container trucks, a la Brexit, could be the first impact from tariffs, which is likely to gum up global trading and potentially choke Q1 growth in the US and elsewhere. It is worth watching US interest rate expectations on Monday, if the market starts to price out the prospect of a rate cut from the Fed this year, this may exacerbate USD strength even more. So far, there has been a slight up tick in implied rates for this year, but there is still one cut from the Fed expected.

2. The Bank of England set to cut rates

The focus will be on the US’s trade tariffs this week, but the Bank of England’s long-awaited meeting on Thursday, is set to deliver a rate cut and the BOE’s updated economic forecasts. The BOE is likely to justify the move, even though inflation remains above target, due to a sluggish economy and a softening in the labour market in recent months. What they do next is of more concern for financial markets. We expect them to continue to say that rate cuts will be gradual, but if they emphasize that the economy is weakening, and the risk of stagnation is growing, then this could be perceived as a dovish message that exacerbates the downside to the pound.

There are currently 3 rate cuts priced in by the market for 2025, including this Thursday’s potential cut. If the BOE does strike a dovish note, that could be increased to four, inline with BOE expectations. While the BOE is likely to push back against political pressure from Donald Trump for global interest rates to moderate, high interest rates are having a detrimental impact on the UK economy. If they are expected to be lowered by more than expected this year, it could act as a tonic for UK stocks to the tariff talk that is likely to dominate markets this week.

3. The US labour market

We will get the monthly health check for the US economy on Friday. At 1330 GMT, the US will report non-farm payrolls, the unemployment rate and wage data for January. Economists currently expect a reading of 170k for NFPs last month, down from 256k in December. The unemployment rate is expected to remain steady at 4.1% and average weekly pay growth is expected to moderate a notch to 3.8% from 3.9% in December. This is an important month for payrolls data as it will also include the annual revisions to the establishment survey, which includes NFPs. the total number of payrolls reported for 2024 is expected to be lowered by just over 700k. This would reduce the average monthly payroll report to 148k from 182k, which suggests a softer labour market that may support a faster pace of Fed loosening. However, the inflationary impact from Trump’s tariffs complicates the picture for the Fed.

We do not think that this week’s NFP report will change the outlook for the Fed, who sounded resolutely determined to pause rate cuts for a prolonged period at their January meeting. This is also a prudent response due to the uncertainty facing the US economy. Not only does Trump’s tariffs threaten the inflationary outlook, but there is likely to be a wave of Federal job cuts and redundancies in the coming weeks that could shift the dial for the unemployment rate. Trump is likely to be more market-moving than payrolls this week, but a large upside or downside surprise could also trigger volatility.