Market Brief: Markets Pare Gains, But Remain Positive 

Global financial markets are still in an ebullient mood after yesterday’s US consumer price index report showed core inflation rising by less than had been feared in December. The dollar reversed lower, ten-year Treasury yields dropped as much as 15 basis points across the curve, and equity markets soared through yesterday’s session, with only small adjustments occurring in this morning’s trading activity.

We’re not sure this degree of relief is justified. Taken in combination with this week’s producer and import price data releases, it looks as if underlying inflation is stabilising just below the 3-percent level—well above pre-pandemic averages—with the core personal consumption expenditures index* set to print at a nearly-unchanged 2.8 percent at the end of the month.

But the US economy is achieving Goldilocks-like outcomes. According to an update this morning, headline retail sales climbed 0.4 percent in the month—topping market expectations—while “control group” receipts, which exclude autos, gasoline, building materials, and office supplies, rose 0.7 percent. The number of initial unemployment claims submitted in the week ended January 11 rose to 217,000 from the prior 203,000, slightly topping expectations for a 210,000-print. The Federal Reserve’s wait-and-see approach seems well-justified for now.

And it is clear that a significant number of bond market buyers are back in top-ticking mode, with many investors hoping to lock in before yields head lower. If all else were equal**, this could reduce speculative demand for the dollar over the coming weeks and help alleviate downward pressure on rate-sensitive economies elsewhere.

In currency markets more broadly, the Japanese yen is the only clear outperformer against the greenback, rising for a third day on firming expectations for a rate hike at next week’s Bank of Japan meeting. The Mexican peso and Canadian dollar are both on the defensive as traders brace for event risks surrounding Donald Trump’s inauguration next week. The British pound is retreating once again after output expanded just 0.1 percent in November, putting the economy on course for a second quarterly period of stagflation.

Incoming US Treasury Secretary Scott Bessent is likely to make reassuring noises during his confirmation hearing today. According to prepared remarks released to major media outlets ahead of his testimony, he will argue for "pro-growth policies to reduce the tax burden on American manufacturers, service workers, and seniors," saying “Productive investment that grows the economy must be prioritized over wasteful spending that drives inflation”.

Bessent will also lend verbal support to the president-elect’s trade plans. “Trump was the first president in modern times to recognize the need to change our trade policy and stand up for American workers,” he will say. “We must secure supply chains that are vulnerable to strategic competitors, and we must carefully deploy sanctions as part of a whole-of-government approach to address our national security requirements”. “And critically, we must ensure that the US dollar remains the world’s reserve currency”.

But he may stop short of providing a full endorsement of the plans outlined in recent months. In a series of interviews and social media posts, Trump has threatened to implement 10-to-60 percent tariffs on products from China, 25 percent duties on Canadian and Mexican goods, and a 10 percent levy on all other imports.

As a former macro investor and George Soros acolyte, Bessent likely has a better understanding of what’s really at stake for the economy than many of his peers in Washington—on both sides of the aisle. Although the US runs large deficits in tangible goods against its major partners, a broader view that includes cross-border services flows shows that the country’s trade relationships are far more balanced than is often believed. The imbalance with Canada, for example, ranks behind China, Mexico, the European Union, Japan, Taiwan, India, and Korea, and represents a rounding error relative to the scale of the US economy.

In currency markets more broadly, the Japanese yen is the only clear outperformer against the greenback, rising for a third day on firming expectations for a rate hike at next week’s Bank of Japan meeting. The Mexican peso and Canadian dollar are both on the defensive as traders brace for event risks surrounding Donald Trump’s inauguration next week. The British pound is retreating once again after output expanded just 0.1 percent in November, putting the economy on course for a second quarterly period of stagflation.

Incoming US Treasury Secretary Scott Bessent is likely to make reassuring noises during his confirmation hearing today. According to prepared remarks released to major media outlets ahead of his testimony, he will argue for "pro-growth policies to reduce the tax burden on American manufacturers, service workers, and seniors," saying “Productive investment that grows the economy must be prioritized over wasteful spending that drives inflation”.

Bessent will also lend verbal support to the president-elect’s trade plans. “Trump was the first president in modern times to recognize the need to change our trade policy and stand up for American workers,” he will say. “We must secure supply chains that are vulnerable to strategic competitors, and we must carefully deploy sanctions as part of a whole-of-government approach to address our national security requirements”. “And critically, we must ensure that the US dollar remains the world’s reserve currency”.

But he may stop short of providing a full endorsement of the plans outlined in recent months. In a series of interviews and social media posts, Trump has threatened to implement 10-to-60 percent tariffs on products from China, 25 percent duties on Canadian and Mexican goods, and a 10 percent levy on all other imports.

As a former macro investor and George Soros acolyte, Bessent likely has a better understanding of what’s really at stake for the economy than many of his peers in Washington—on both sides of the aisle. Although the US runs large deficits in tangible goods against its major partners, a broader view that includes cross-border services flows shows that the country’s trade relationships are far more balanced than is often believed. The imbalance with Canada, for example, ranks behind China, Mexico, the European Union, Japan, Taiwan, India, and Korea, and represents a rounding error relative to the scale of the US economy.

Bilateral trade balance data also obscures the extent to which US businesses generate revenues in other countries. Once sales by majority-owned subsidiaries to domestic purchasers in other countries*** are added in, imbalances between the US and China, Canada, and Mexico are dramatically reduced - and even flipped. Efforts to fully decouple from other economies could backfire dramatically, lowering domestic investment and impacting US equity markets in a painful way.

As such, it seems unlikely the Trump administration will prove willing to stomach the economic pain associated with an all-out trade war. We may be taking an overly-optimistic view, but global growth could emerge relatively unscathed from a period in which markets suffer bouts of extreme volatility as alarming headlines are followed by unpredictable, but ultimately economically-neutral negotiations. From a currency standpoint, a cooler-heads-prevail outcome should see the greenback’s outperformance begin to fade in the second quarter and beyond, even if it remains high for now.

*As a sell-side analyst, I’m contractually obligated to add that the core personal consumption expenditures index is… stop me if you’ve heard this before… “the Federal Reserve’s preferred inflation indicator”.

**Of course, all else isn't equal.

***Note that multinational value chains can be incredibly complex, and in Canada’s case can be swayed by changes in oil prices, so these numbers should be taken with a grain of salt.

****Distribution of the Market Brief will pause tomorrow unless something dramatic happens. We’ll land in your inboxes again on Monday.

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