As investors attempt to keep up with the daily shift in President Trump’s tariff policies, the February CPI report out of the United States on Wednesday will likely come as a much-needed distraction. Specifically, the inflation data may signify the start of a new downward path for the CPI measure, following in the footsteps of the January PCE figures.
The Fed’s fight against high inflation hasn’t been easy. The recent uptick in price pressures must have been frustrating for policymakers to say the least. But US inflation appears to be turning a corner now and is expected to head lower over the next few months.
There is one problem – tariffs. Trump’s decision to go ahead with levies as high as 25% against Canada and Mexico and raise them by 20% for China, not to forget the sectoral and reciprocal tariffs that have yet to be finalized, could derail the Fed’s battle to steer inflation all the way down to 2.0%.
In January, the headline rate of CPI climbed to the highest since June 2024, reaching 3.0% y/y. Core CPI also edged up, rising to 3.3% y/y. But the February data will likely end months of worry that inflation is rearing its ugly head again, as headline CPI is projected to moderate to 2.9%, while core CPI is expected to decline to 3.1%. The month-on-month forecasts for both are 0.3%.
On Thursday, the producer price index for the same month will shed further light on underlying price pressures in the US economy, and on Friday, investors will turn their attention to the University of Michigan’s preliminary consumer sentiment survey for March. Last month’s survey sparked some concerns as it showed consumers’ inflation expectations creeping higher. In particular, five-year expectations rose to a 30-year high.
Can the dollar recoup some lost ground?
A continuation of this uptrend would cast doubt on the notion that the inflation outlook is improving, arguing for ongoing caution at the Fed.
However, looking at Fed rate cut expectations, it seems that investors have already made up their minds that inflation no longer poses a threat, and that the bigger danger is economic growth grinding to a halt on the back of Trump’s protectionist trade policies.
Yet, with the US dollar having tumbled by more than 3% over the past week, any upside surprises in the incoming price indicators could spur a rebound.
BoC rate cut may hang in the balance
The Bank of Canada meets on Wednesday to set interest rates, keeping the spotlight on the country amid the trade spat with the United States. Unlike his Mexican counterpart, Prime Minister Justin Trudeau has not held back in announcing retaliatory tariffs on imports from Canada’s southern neighbour and by far its biggest trading partner.
Hence, this escalation is not only expected to deliver a severe blow to Canada’s economy, but it could also lead to higher prices on C$125 billion worth of goods imported from the US.
But it may not come to that, as Trump just signed new executive orders delaying the 25% tariffs on almost 40% of goods entering from Canada until April 2. In response, Trudeau has put on hold his latest counter levies.
For the Bank of Canada, however, this still poses a major policy dilemma. Following the Bank’s aggressive rate cuts last year, the Canadian economy is bouncing back, with employment surging, although consumer spending remains somewhat patchy. More importantly for policymakers, there are signs that inflation is bottoming out.
Having already slashed rates by a total of 200 basis points, it makes sense for the BoC to take to the sidelines. But the downside risks to growth from Trump’s tariffs will likely sway policymakers to cut again in March.
Investors have assigned a 66% probability of a 25-bps reduction in the target rate. The Canadian dollar therefore stands to see a strong reaction either way. Although in the scenario of a rate cut, the loonie might even appreciate against the US dollar if the BoC signals that a pause is on the horizon.
It’s possible of course that Trump may steal the BoC’s thunder if there are any further tariff developments over the next few days, keeping loonie traders on standby.
Will UK data spoil the pound’s bullish streak?
The pound, along with the euro, have benefited the most from the dollar’s pullback. Sterling has set its sights on the $1.30 handle, recovering sharply from its January lows. However, it’s uncertain how sustainable this rally is as the UK economy is grappling with its own problems even in the absence of a direct tariff threat.
On Friday, investors will be keeping an eye on the latest monthly output figures on industrial, manufacturing and services production, as well as aggregate GDP.
There was a surprise rebound in GDP growth in December, providing some reprieve for the embattled Labour chancellor, Rachel Reeves. But if growth faltered again in January, the pressure on Reeves will increase ahead of the March 26 Spring Budget Statement to come up with stronger measures to support the economy.
Yen gets caught in Trump’s trade storm
The Japanese yen, on the other hand, has been the laggard among the major FX pairs, despite the Bank of Japan maintaining its hawkish rhetoric. The underperformance could be related to Trump's remarks about Japan manipulating the yen to keep it weak, raising speculation that Tokyo could be next on the President’s tariff hit list.
In the meantime, there’s a flurry of releases out of Japan in the first half of the week. Wage growth and household spending data for January on Monday and Tuesday, respectively, will be important in gauging whether Japanese inflation is on a sustainable path of sticking near the BoJ’s 2% target. Revisions to Q4 GDP growth are also due on Tuesday, while on Wednesday, corporate goods prices for February will be watched.