Weekly Focus - Tariff announcements gave markets a roller coaster ride

Donald Trump caused a significant market reaction this week by announcing steep tariffs on Canada, Mexico, and China starting from 4 February, which pushed the broad USD higher and sent equities lower. However, after he quickly put the tariffs on Mexico and Canada on hold for a month, the market reaction reversed, and overall equity indexes ended the week higher due to positive earnings reports. Although the outcome remains unclear, we anticipate more tariffs on China later this year, with the EU and possibly other countries being affected soon after. The new tariffs are linked to border security and could be removed or reduced following negotiations, though there is a risk of a tit-for-tat escalation in the short term. China's package of retaliation measures includes 10-15% tariffs on US energy imports and export controls on five metals used in defence, clean energy, and other industries, showing its readiness to engage in conflict if Trump is inclined to do so. 

On the data front, HICP inflation in the euro area increased to 2.5% y/y in January, slightly above expectations for an unchanged print at 2.4% y/y. The increase was entirely due to energy inflation while food inflation declined, and core inflation was unchanged at 2.7%. Despite the elevated yearly growth rates, the most recent monthly price increases on core inflation rhymes well with 2% annualised inflation. On the political front, French prime minister Bayrou managed to pass the 2025 budget and survive a no-confidence vote.

In the US, the ISM manufacturing index rose more than expected to 50.9 from 49.3, reaching its highest level since September. This increase aligns with the PMI surveys and indicates positive momentum for the US manufacturing sector. In contrast, both the services PMI and ISM fell in January, with the ISM index dropping to 52.8 from 54.0. Data on US productivity in Q4 showed that productivity growth weakened. Although the data is volatile, the current pace is now close to the pre-pandemic trend of around 1%, down from over 3% seen in the second half of 2023. This indicates that structural growth is slowing, meaning firms will either need to pass a larger share of nominal wage costs onto their selling prices or absorb them into their margins.

The Bank of England lowered the policy rate by 25bp to 4.50% as widely expected. At the same time, the BoE delivered a dovish twist to its guidance as two members voted for a larger 50bp cut and they lowered their growth projections, see BoE Review, 6 February.

Next week, the key data release will be the US January CPI, while US politics will also remain in focus. We forecast US headline inflation at 2.9% y/y and core inflation at 3.1% y/y. Attention in the US will also be on Fed Chair Powell's congressional testimony on Wednesday and US retail sales on Friday. In China, CPI and PPI data will be released on Monday, with focus on whether a call between Xi Jinping and Trump, cancelled this week due to China's retaliation to Trump's 10% tariffs, will take place. In the euro area, data releases are limited, but Q4 employment data on Friday will be a highlight. Additionally, the US is set to unveil Trump's plan to end the war in Ukraine at the Munich Peace Conference starting on Friday.

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