Quarterly Outlook
Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Global Head of Macro Strategy
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The euro is not feeling as much pressure as Europe.
John J. Hardy
Global Head of Macro Strategy
Summary: Geopolitics are the focus in Europe this week far more than the ECB, with the next summit of EU leaders on Thursday. An important US tariff deadline is up tomorrow, with CAD most in the spotlight.
Euro rebounds even as pressure on Europe ratchets higher
Geopolitics and swings in risk sentiment have dominated the news flow since my report last Thursday. The Zelenskyy debacle at the White House on Friday has redoubled pressure on Europe to muster its own response to the war situation in Ukraine and European defense stocks spiked higher still to open the week. The situation is too fluid to comment on every mini-summit and turn of events, but even if the US does move to commit to security guarantees for Ukraine in exchange for the “minerals deal”, the overall sense of a weakening transatlantic alliance continues and means that Europe will have to drastically raise its defense spending. The timing is awful for the most important player Germany, as CDU leader Friedrich Merz faces a pressure cooker of a timeframe for forming a government with a coalition partner that has conflicting priorities. The outlook for the euro pulled higher by the prospects of a significant fiscal expansion, but dogged by Trump tariff threats as well as whether Germany will fully commit to the EU agenda or prove fiscally cautious or even more self-interested.
Meanwhile, the euro got a solid boost this morning from a hotter than expected flash core CPI number from the Eurozone – at 2.6% YoY vs. 2.5% expected, though down from 2.7% in January.
Chart: USDJPY versus US-Japan 10-year yield spread
The backup in USDJPY last week from the attempts below 149.00 don’t make much sense if USDJPY is meant to continue following the moves in the spread on 10-year US versus Japanese yields, which it largely has in recent years with only brief episodes of straying from that correlation. The most notable of these episodes in the last twelve months was last summer’s super-charged extension of the JPY carry trade until the Bank of Japan surprised with a larger than expected rate cut on July 31 and the FOMC waxed a bit more dovish than expected as well on the same day. This brought USDJPY crashing down, with some follow through to the 140.00 area as the yield spread bottomed out around 275 basis points. At 282 basis points currently, we should arguably be trading well south of 145.00 here, although some might argue it is more about the absolute level of the US 10-year yield (the blue line) rather than the spread, in which case the “mispricing” looks far more modest. Whether it is general Trump tariff threats or the Bank of Japan’s recent threat to intervene if BoJ yields rise sharply, something has held the JPY bulls back from taking the pair lower. It will be interesting to see if the dam breaks if we get another approach on the critical 148.65 area. In addition to the suspense on whether we continue to see a correlation of USDJPY with the US-Japan long yield spread, I have asked the question of whether the yen level if of geopolitical concern for Japan, and suspect the answer is yes. It is easier for Japan to cruise under the Trump tariff radar if it continues to make the right noises on investing in the US and if its currency is in the 120-130 area versus the US dollar with a BoJ rate of at least 1%. Note that the end of March is the end of Japan’s financial year as well.
The week ahead: US economic data, ECB and tariffs/geopolitics
Geopolitics and tariffs are at the top of the agenda day-to-day across markets, but we do need to consider the important US economic data up this week as US recession risks are getting more play after a spike in the US jobless claims last week and as well after the Atlanta Fed’s GDPNow level for February dropping to -1.5% after several months of readings above +2.0%. the key numbers for the US are the usual first-week-of the month numbers, with the ISM Manufacturing survey up today, the more important ISM Services survey up Wednesday. The labor market data includes the ADP payrolls change number on Wednesday, the suddenly more important weekly claims number on Thursday after last week’s spike, and then the usual jobs report on Friday.
The ECB meets on Thursday and is set to chop the rate another 25 basis points – guidance will be watched for any indication on the April meeting, which is not fully priced (about 70%) for another rate cut, but Europe and the euro are more caught up in the geopolitical lay of the land, the threatened April 2 tariffs and the outlook for fiscal more than whether the ECB cuts a bit more or less this year. ECB officials have been all over the map with their comments, and with so much uncertainty both geopolitical/tariff-driven and fiscal, the ECB can’t possibly provide firm forward guidance.
Important tariff deadline tomorrow
The USD outlook is pivotal on tomorrow’s decision from the Trump administration on whether to go forward with the 25% tariffs on Canada and Mexico, or if they will be reduced or delayed once again. (We can infer from US Commerce Secretary Lutnick’s comments at the weekend that the decision will be made at the last minute. According to Lutnick, Trump is considering “how exactly he wants to play it with Mexico and Canada, and that is a fluid situation.” I will be surprised if we get the full 25% for either country, as would the market, which has priced more concern for CAD than for MXN – but do we get another 30-day punt, a cancellation or 10% or 5% or….?)
The 10% additional tariff on China is also in play and is more likely to go ahead. For its part, China’s political leadership is caught up in the “two sessions” that end on March 11 and are highly anticipated as we await signals on how much stimulus is on offer for the economy, especially to drive consumption, as well as on the scale of support for the private sector.
NEW FX Board of G10 and CNH trend evolution and strength.
Note: If unfamiliar with the FX board, please see a video tutorial for understanding and using the FX Board.
The JPY trend remains intact, but needs “refreshing” with some new momentum to cement its status. The SEK trend has been remarkably consistent and fits with expectations for a significant European fiscal expansion. Elsewhere, it is interesting to note that AUD and NZD couldn’t catch more of a bid on the snap-back in risk sentiment on Friday. Australia is being circumnavigated by a handful of Chinese navy vessels after these conducted unannounced live-fire exercises the week before last. Has a geopolitical premium worked its way into the picture for the Aussie?
Table: NEW FX Board Trend Scoreboard for individual pairs.
AUDUSD flips to negative today without a significant rally into the close and USDCAD and NZDUSD flipped to USD-positive status on Friday’s close – the status for EURUSD and USDCHF is in play as well after the EURUSD couldn’t make a break higher recently.
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