US inflation stays stable, but tariff risks remain elevated as US/China talks break down

US equity market futures are pointing to a lower open for the US on Friday, as the market digests a social media post from the White House said that China had violated its agreement with the US. Trump blames himself for this, saying that he was too nice to China two weeks ago when they agreed new terms of trade and lowered tariffs. It highlights how fluid the tariff situation remains for market sentiment, both on the upside and the downside.

Risk sentiment fades into the weekend

The S&P 500 is set to open down 0.5%, the VIX is creeping back to the 20 level, and is also above its 12-month average, which is a sign that investors are cautious about the outlook, which could lead them to scale back their risk taking as we move into the weekend.

Inflation unlikely to move dial for Fed

The tech giants, including Nvidia, are set to open down slightly, even though the Fed’s preferred inflation measure, the core PCE moderated  a notch to 2.5% for April from 2.6% in March, and the headline figure also fell back to 2.1%. This data is unlikely to be an important component of Fed policy going forward for two reasons. Firstly, the gauge of prices from April is too out of date and does not reflect the impact of tariffs, since they were paused in mid-April. Secondly, tariffs are so fluid right now that the impact on inflation is difficult to gauge. A more impactful gauge for monetary policy right now is the labor market. If job creation dips and if the unemployment rate rises, that could be a trigger for rate cuts, while the Fed waits to see the impact from tariffs on inflation.  

Could Trump slap tariffs on China once again?

For now, the moderation in risk sentiment has been mild, US stocks are poised to open lower, while European stocks have backed away from their highs. The real souring in risk sentiment could come down the line, either later today or during the weekend, if President Trump decides to reapply tariffs to China. Nothing can be ruled out at this stage, which is why we expect investors to sit on the sidelines. However, in the current environment, make no mistake, investors are ready to pull the trigger on this risk rally, rush to the exits and book profits after a stunning recovery in risk assets in recent weeks.

If President Trump does slap tariffs back on Chinese imports to the US, as a violation of their ‘agreement’, then we may see demand for US assets, and the dollar, severely impaired by a chaotic and undiplomatic approach to trade policy.

The dollar is higher on the day and it has been in recovery mode this week and is the top-performing currency in the G10 FX space. However, it is still fragile. It remains the weakest currency in the G10 so far this month, and a re-escalation in the trade wars between China and the US could also slow down or reverse any potential recovery. If the dollar index can remain stable, even as China and the US tensions resurface, it would suggest that the dollar index is stabilizing around the 99.00 lows.

Record drop in trade deficit, show tariffs are working

The economic data from the US was not all bad news, personal income was stronger than expected, which bodes well for the US consumer. It rose by 0.8%, exceeding expectations for a 0.3% increase.  Added to this, the advanced goods trade deficit shrunk sharply, the deficit fell to $87.6bn in April, down from $162.3bn in March. This is the lowest level for the deficit since 2023 and it is a record monthly drop. Imports fell by nearly 20%, due to consumer goods and industrial supplies, which are mostly shipped from China. A smaller deficit could boost the dollar; however, it suggests that retailers may take a hit since there would not have been time to pivot away from imports and towards domestic supplies. This could lead to empty shelves in some stores in the coming weeks. It also suggests that tax revenue from tariffs may not be enough to fund President Trump’s massive tax bill, although that is not reflected in the bond market right now, and US Treasury yields are lower on the day.

The oil price has also been in focus on Friday after reports suggest that Opec + will announce a larger than expected hike to production targets, boosting supply. This comes at the same time as demand concerns remain elevated now that President Trump is picking at the scab of recently healed trade tensions.

Why US stocks may struggle to rally, as the Dollar catches a bid

For now, we think that US stocks, which are on track to rise more than 1% this week, could struggle to rally into the end of the week. There is a risk that the US will apply tariffs to Chinese imports once again, legal or not. Compounding these fears is a lack of direction from the Fed about its future policy decisions. The Fed is said to be data dependent, but as today’s PCE data showed, it could take some time before the US economic data shows the impact from tariffs.

The Dollar might be the only asset that catches a bid on Friday. It is one of the top-performing currencies in the G10 FX space today, as a sharp drop in imports boosts demand for the dollar.