2025.02.03 Weekly
There are many drawing parallels to the last trade war initiated by Trump on China where we saw inflation fall and a negative growth impact. While consensus believes tariffs are both inflationary and negative for growth, there seems to be a growing consensus that the inflation impact will be temporary as a result of the negative growth shock — i.e. the same as last time, and therefore great for bonds.
Brent Donnelly examined this issue through 2 parts — One: Look at recent history, and Two: Psychology has changed and tariffs will be inflationary. For first, he looked at what TLT did on prior announcements during Trump 1.0 and I took that a step further by looking at yield curve changes.
Though are some overlaps on some of those announcements for the 5 and 10day fwd changes, we can conclude that Trump 1.0 was largely about bull flattening with longer end yields reflecting signifying that the market was more concerned about growth, and little about inflation.
But the economic backdrop in 2018 was very different to what we have (now): Growth was peaking while a global growth slowdown was already a major concern before the implementation of tarrifs 1.0 (US growth expectations remain more robust); Inflation was relatively low at the time with core-pce mostly below 2% that year and was the norm in the pre-pandemic world (compared to roughly 3.2% core pce now); and the Fed was tightening policy and hiking interest rates that year which obviously had a hand in slowing growth and inflation (compared to a fed that has been cutting rates the last 6months with policy now seen to be less restrictive).
Tying in with Brent’s second point about inflation psychology, inflation in the post-pandemic era is now much stickier than it has been for decades (Orange line — 1yr inflation swaps). What’s interesting is that the 1yr 1yr-forward inflation expectations (Purple) did surge from the middle of 2018 when the trade war was getting into full swing.
If we take into account that 1) tariffs causes inflation expectations to go higher, and 2) the US economic backdrop is more robust than it was in 2018, then it would be logical to assume that inflation is more likely to persist than it did in 2018–19 also. That assumption would lead to me believe that 1) US growth may not be so negatively impacted given some structural differences to the pre-pandemic world, and 2) inflation may be more persistent with a higher base-line than we had in the pre-padnemic world.
I’m not completely sold that long bonds (and short stocks) is a theme that will perform this time round.
Macro review
Central bank meetings
4 major central banks had policy announcements last week which largely went as expected. A few highlights:
- BoC cuts 25bps to 3% and signals “a more gradual approach” going forward. Quantitative tightening to end and asset purchases to begin (to rebalance/normalise the balance sheet). Growth expectations revised down to 1.8% from 2.1 with the threat of tariffs weighing in.
- ECB cuts 25bps to 2.75% reiterating data dependence and a non pre-committed path. I looked for comments on inflation pressures flagged by PMI reports (reviewed last week) but nothing mentioned other than growth still being weak ‘but expected to rebound’ (*chuckles).
- FOMC holds rates steady, changes to the policy statement appeared hawkish but Powell later said it was simply a ‘clean-up’ of language and not a signal. Even so, there were some subtleties in the statement that had a hawkish lean, for example labour market conditions was upgraded from ‘having generally eased’ to being ‘solid’ while other slight wording changes indicates that the Fed is far less concerned of downside risks, and the MacroHive LLM seems to agree with the hawkish lean.
Data
PCE report was strong and confirming what we already knew — core/services inflation is easing, headline accelerating.
Consumption (Personal spending) was 0.7% beating expectations of 0.5%, while Incomes was higher in December as expected.
CB consumer confidence fell to 104.1 from an upwardly revised 109.5 in December and missing expectations of 105.6. 6-month expectations were all lower for a 2nd consecutive month also with the labour market differential going negative.
Initial claims back below the 4wk-average while continuing claims eased.
Advance GDP was 2.3% for 4Q2024, widely missing expectations of 2.7%. Perhaps this could see upward revisions in the next releases given that the Atlanta Fed’s estimate was seen mostly above 2.5%.
ECI was as expected at 0.9%, a touch higher than the prior quarter. Jason Furman goes into the details surmising that the decline in the ex-incentives measure is consistent with a 2.5% inflation world.
EQUITIES
Since the above post, NYSE net advancing issues did pick up a little bit in the afterhours after going the most negative since at one point on Friday.
The decline was broad with momentum swinging lower to finish the week.
Short squeeze — the most shorted stocks index rallied almost 10% off the recent low, compared to SPX doing +3.36% of the prior swing low.
Volatility metrics are still quite low however and not quite signalling the kind of fear you may expect with a strong reversal. Perhaps a new month may bring in some fresh downside positioning to see these metrics tick higher this week.
COMMODITIES
Bloomberg commodities index still elevated since the start of the year.
Industrial metals sub-index (L) are trading heavily and probably wont see much relief after the latest tariffs. Precious metals (R) continues to look strong.
Energy (L) looked as though it was building a base last week after the 50% retracement, I’ve gone long Brent crude looking for a decent breakout leg. Agriculturals sub-index (R) continues to rise adding to my concerns about headline (not core) inflation being an issue again.
RATES
US yield curve has been bull flattening. I suspect this will continue to be the theme while I think the risk is that treasuries are susceptible to sell-offs due to shorter term inflation expectations getting more elevated on tariffs, and economic data continues to be solid.
10yr yield is at an interesting juncture here technically, and I while I’ve maintained a slightly upward bias from 4.5% being well supported (as we saw last week), a potential break here creates some 2-way risk.
FX
DXY has met the short-term breakout objective around 109.40 after I’ve flagged the demark 9 countdown and reversal bar low printing at a key pivot level. I’m still of the opinion that DXY is on its way to the 111 handle expecting EURUSD to hit parity, and possible USDCHF at a much later point should the next fed cut be delayed to the point that the risk is just one or no cuts this year.
I’m still quite the believer in JPY longs as I don’t think inflation is a thing of the past, and like I outlined in the opening comments re tariffs, I don’t think long bonds is a clear cut high conviction theme which you would need to see USDJPY trade 150 and below. Instead, I like position trading longs on this retracement looking for another crack at the 160 handle on the view that accelerating headline inflation could provide the fuel to put this pair on an uptrend again.
Another theme that gets my interest is AUDNZD short. NZD terms of trade (Purple) has started the year strong while AUD’s (Orange) is only marginally higher; relative economic surprises is a touch lower (Green) in favour of NZD; 2yr rate differentials is showing signs of rolling over; metals trading weak compared to Agriculturals; slump in GDT auctions could be over after the last rebound; and tariffs hitting Chinese industry as opposed to consumption would thematically help the pair lower.
Technically its been in a very tight consolidation range and has given out to the downside last week. It’s now retesting the upper trendline offering an attractive entry point.
Other major USD charts are in a tricky spot after hitting some major technical levels and looks in danger of reversing. Will monitor and post on x as it develops but generally continue to favour USD longs vs EUR GBP CHF and JPY.
That’s all for now, good luck trading.
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