Market Brief: Markets Steady As Event Risks Loom

Currency traders are treading cautiously after Donald Trump raised taxes on steel and aluminum imports into the United States, and price action is slowing ahead of this morning’s testimony from Federal Reserve chair Jerome Powell and tomorrow’s inflation update. North American equity futures are setting up for a negative open, the benchmark ten-year Treasury yield is up roughly 2 basis points, and the dollar is consolidating gains achieved in the run-up to last night’s tariff announcement.

President Trump signed two executive orders last night imposing 25-percent tariffs on all steel and aluminum products, saying “It’s a big deal. This is the beginning of making America rich again” and warning “It’s 25 percent, without exceptions or exemptions. And that’s all countries, no matter where it comes from”. Of course, with the deadline—along with the putative drop-dead date to impose significantly wider tariffs on Canada, Mexico, and China—still three weeks away, and Trump’s long track record to look back at, investors expect exactly the opposite dynamic to play out, with politically-favoured businesses and countries gaining carve-outs in the coming days and weeks.

The euro is pushing higher despite warnings from the European Union suggesting that it will respond to any tariffs imposed with trade barriers of its own. The pound is trading slightly stronger even after Bank of England Monetary Policy Committee member Catherine Mann—previously one of the most hawkish officials on the rate-setting committee—told the Financial Times that she was seeing demand conditions in the economy that were “quite a bit weaker” than before, justifying a pivot toward easier policy. The safe-haven yen and Swiss franc are both up as traders seek shelter from still-elevated volatility in foreign exchange markets.

We don’t expect this round of tariffs to hit any economy particularly hard. Psychological effects could be substantially larger, but steel and aluminum exports make up a relatively-small share of gross domestic product in most countries, and aren’t likely to shift dramatically in response to an increase in US import prices. The focus on countries like Canada and Mexico is interesting, however, in the sense that it exposes something about Donald Trump’s approach to geopolitics: he has, again, chosen to hit close allies of the United States far harder than any of the country’s traditional adversaries, reversing Republican orthodoxy going back to Reagan and beyond. The global order seems to have been turned on its head.

In follow-up comments on Friday’s threat to impose “reciprocal” tariffs on other countries, Trump said “If they charge us, we charge them. If they’re at 25 we’re at 25. If they’re at 10, we’re at 10,” suggesting that our original interpretation is holding up: that the new administration intends to simply match tariffs imposed by other countries. This should mean that developed economies—which mostly maintain the same tariff rates on products as the US (outside the agricultural and auto sectors)—wouldn’t suffer any meaningful impact, while emerging market countries, many of whom have raised tariff barriers to protect “infant industries” might experience bigger shocks.

It’s ‘Bring Your Dad to Work Day’ in Congress, with Federal Reserve Chair Jerome Powell due to deliver semi-annual testimony in front of the Senate Committee on Banking, Housing, and Urban Affairs. We expect him to lay out the rationale for an extended pause in the central bank’s easing cycle, emphasising strong fundamentals in US labour markets, consumer spending, and business investment, along with steady—albeit slow—progress toward the inflation target as reasons to stay on hold for now. In an echo of the post-decision press conference, he is likely to parry questions on expected changes in US immigration, trade, and fiscal policies*, outlining a wait-and-see approach that focuses on what the Trump administration actually implements, rather than what it announces. In a departure, he could downplay the extent to which short-term changes in inflation expectations might influence policy, given that noise levels are clearly influencing consumer views in a way that doesn’t necessarily reflect fundamentals.

To wit, consumers may be less fearful than we suggested yesterday morning: the New York Fed’s survey of consumer expectations for inflation at the one-year horizon were unchanged in January at 3 percent, countering Friday’s University of Michigan survey, which showed a sharp rise in median price forecasts: perhaps illustrating methodological differences that reduce partisan bias. A measure which captures the probability of various inflation outcomes—distinguishing between deflation, inflation between 0 and 2 percent, between 2 and 4 percent, and over 4 percent—shows households becoming slightly more worried about a resurgence in price growth than they were in the late autumn, but nowhere near the levels reached in early 2022.

Tomorrow’s US inflation report could prove noisy. An ever-accelerating pace of price changes across the economy** hasn’t changed the fact that many businesses deliver price increases in January—leading to a phenomena in which early-year consumer price index releases tend to surprise to the upside—and new seasonal adjustment factors, combined with annual revisions, could make it difficult to interpret what the data is telling us. A circa-0.3-percent month-over-month increase in core prices should confirm some “stickiness” in underlying inflation pressures—further justifying the Fed’s reluctance to keep easing—while allaying fears of a sudden overheat.

*But considerable time is also likely to be wasted on questions regarding the central bank's social policies, again echoing the last press conference in resembling a Maoist "struggle session" more than an exploration of economic fundamentals. It's entirely possible that nothing market-moving emerges from the discussion itself.

**See Alberto Cavallo's wonderful 'More Amazon Effects: Online Competition and Pricing Behaviors' paper for more on this.

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