- Markets trade at the mercy of Trump’s tariff rhetoric
- Fed to pause due to Trump uncertainty and strong US economy
- Investors may lock gaze on forward guidance
- Thursday’s GDP and Friday’s PCE data in focus as well
Trump Remains the Main Market Driver
With Trump’s inauguration behind them, investors are slowly preparing for Wednesday’s FOMC decision. Yet, the meeting will be held in the shadow of Trump’s policies as the new president said just hours after taking office that he is planning to impose tariffs of 25% on Canadian and Mexican imports on February 1. He didn’t hesitate to threaten China and Europe as well.
The US dollar corrected sharply lower ahead of Trump’s inaugural address on headlines that he will not sign any executive order on tariffs on the first day. However, traders cut their dollar short positions following a new conflict with Colombia over the weekend. Trump threatened to impose tariffs on the South American nation to punish it for refusing to accept military flights carrying deportees, with the Colombian government responding that they will retaliate. However, soon thereafter, the White House said that the two nations had eventually agreed.
For some market participants, whether Trump will proceed with tariffs on day 1 or day 5 (or day 20) doesn’t play a big role. Fears of inflation resurgence have not disappeared, and this is evident by Fed fund futures, which suggest that investors are penciling in around 45bps worth of rate reductions this year, fractionally fewer than the Fed’s upwardly revised dot plot that indicated 50bps. And this is even after the US CPI numbers for December came in somewhat softer than expected.
Besides Trump’s tariff plans, what has also been allowing investors to maintain a relatively hawkish stance is the strong performance of the US economy, and especially the labor market, which saw strong job growth in November and December.
Fed to Stand Pat Amid Tariff Ambiguity
For this meeting, the financial world is virtually certain that the Fed will remain sidelined. And indeed, the current fundamental landscape argues that this may be the wiser choice. It may be best for policymakers to wait and see what Trump will announce on February 1, and how the data unfolds thereafter. They will have plenty of time to reevaluate their way forward as the next gathering, at which they will release updated economic projections and a new ‘dot plot’, is scheduled for March 19.
Therefore, attention this Wednesday is likely to fall on the statement accompanying the decision and Powell’s press conference thereafter. Powell may find himself between a rock and a hard place given that Trump urged global central banks to lower interest rates while addressing the World Economic Forum, at a time when inflation has been proving somewhat hotter than expected and tariffs could fuel it further.
Will Powell Maintain a Cautious Stance?
If Powell wants to highlight the Fed’s independence, reiterating the notion that the Committee is in no rush to lower interest rates and also expressing concerns about inflation due to the policies of the new US government, the dollar is likely to resume its prevailing uptrend as investors scale back their rate cut bets. They may consider only one quarter-point reduction to be appropriate this year, a view that was reflected on Fed fund futures ahead of the December inflation data.
For the dollar to go for a larger correction, Powell may need to sound confident about inflation returning to their 2% target soon and corroborate the idea that a rate cut may be in the works for the first half of the year. Such a stance could prompt market participants to add some more basis points worth of rate cuts for this year.
That said, whatever Wednesday’s outcome is, the US data on Thursday and Friday could also play a big role in reshaping investors’ thinking. On Thursday, the GDP data is expected to show that economic activity in the US slowed somewhat in Q4, still pointing to a solid pace though. On Friday, the core PCE index, which is considered to be the Fed’s favorite inflation metric, will be closely monitored.
Euro/Dollar Breaks Key Downtrend Line
From a technical standpoint, the euro/dollar emerged above a near-term downtrend line on Friday and hit resistance at 1.0525. The move suggests that some further advances may be on the cards, perhaps until the bulls test the 1.0630 zone, or the 200-day exponential moving average (EMA). On the downside, a dip below 1.0340 may switch the outlook back to bearish and encourage declines towards the 1.0215 key support area.