To tariff or not to tariff…

Market action over the past 24 hours or so has been dominated by Donald Trump’s decision to impose tariffs on Mexico, Canada, and China (and threaten them on the EU “soon”); the subsequent decision to pause the introduction of tariffs on Mexico and Canada for a month following talks with the respective leaders of the two countries; and (overnight) China’s retaliatory action with tariffs on the US. In FX, the dollar rose across the board in early trading yesterday but has since given back a good chunk of these gains. The euro briefly hit an intra-day low of just under $1.0150 against the US currency but has since recovered to around $1.0330, still down more than half a cent from Friday’s close, while sterling fell to a low of $1.2250 but is now trading just north of $1.24, little changed from last week’s close. EURGBP has slipped further at the start of this week, to around £0.8315, down almost half a penny from the end of last week.

In equity markets, both US and European stocks finished in the red but off their lows of the day, shedding about 1%, while the latter have opened in positive territory this morning. In bond markets, US yields were higher on the day, led by an increase in 2-year yields (+5bps), as the market viewed the inflationary consequences of tariffs on US imports as limiting the room for the Fed to lower interest rates, while Euro area yields fell, led by the short-end (German 2-year yields fell by almost 10bps), with any imposition of tariffs on Europe seen dampening economic growth and reinforcing the case for interest rate cuts.

Yesterday’s economic data took something of a back seat amid the drama caused by Trump’s tariffs. In the Euro area, the flash inflation reading for January came in a little higher than forecast, with the headline rate nudging up to 2.5% from 2.4% in December and the core rate remaining at 2.7%. This shouldn’t worry the ECB too much as it expects inflation to “fluctuate” around current levels in the near-term before declining during the course of this year. Meanwhile, in the US, the ISM index of manufacturing activity moved into positive territory (>50) in January for the first time since October 2022, driven by a second consecutive month of rising order books.

Looking to the week ahead, the Bank of England announces its latest interest rate decision on Thursday, with the market fully priced for a 25bps cut to 4.5%, while the key economic data release is the US employment report for January on Friday. For today, data scheduled include job openings and factory orders in the US.