Image Source: UnsplashMARKETSAhead of next week’s pivotal inflation report and a Federal Reserve meeting expected to maintain the status quo, US stocks pulled back on Friday, pausing the recent surge as investors evaluated a fresh round of earnings, debated upcoming Big Tech earnings, and considered President Trump’s potential softening stance on China. This week was bolstered by The President’s advocacy during a Davos call for reduced US interest rates, lower oil prices, and tax cuts. He also announced a significant tech infrastructure deal involving industry giants that injected optimism into the markets. Despite the afternoon hiccup, the major indexes closed the holiday-shortened week with gains just under 2%, highlighting the influence of Trump’s comments even amid skepticism about his ability to implement these ambitious changes.On Thursday, Trump hinted he might avoid imposing tariffs on China, which tempered some fears of an escalating trade war. Yet, it’s crucial not to be lulled into complacency; maintaining some tariff hedges seems prudent as tariffs remain a cornerstone of Trump’s policy agenda, albeit potentially delivered more softly than initially feared. Additionally, the dollar has weakened as the tariff risk premium diminishes, further bolstered by Trump’s pledge to ensure LNG supplies to Europe and even hinting at a potential peace deal in Ukraine, which has seen Eurozone stocks outperform the S&P 500 significantly this year.Asset managers are reassessing the massive valuation disparities across the Atlantic as capital trickles back into European markets, prompted by a lifting of excessive pessimism. But the continent faces profound challenges: besides the lame-duck governments in France and Germany, the growth outlook is the bleakest in decades, and ongoing political turmoil underscores the contentious nature of economic policymaking in the region. As Europe transitions from crisis to crisis, the start of 2025 feels ominously weak, with a pervasive sense that growth might falter again amidst a shifting socio-economic climate. The proverbial can, which has long been kicked down the road, is running out of tarmac.
FOREXNavigating these turbulent waters demands keen vigilance. As traders, we often find ourselves playing a reactive game, closely tracking the unpredictable arc of Trump’s policy maneuvers—much like keeping our eyes on a bouncing ball. We must adeptly respond to each new policy spin and its potential ripple effects across global markets.Navigating the FX trading landscape has been more about strategic observation than aggressive action for me this year. Adhering to a decades-long principle, I recognize there’s a time and place for bold moves—and this isn’t it. Most FX traders operate on an eight-week horizon, relying on a method akin to super-forecasting, which involves diligent research, interpreting speeches, analyzing data, and understanding market drivers from various perspectives, but even the eight-week lens is foggy. Despite some notable market movements, my approach has been conservative day trading.Sure, there’s a growing perception that President Trump is not delivering on his pre-inauguration protectionist promises. The expectation is that many of his tariff threats may not materialize, assuming some trade concessions are made. However, the pendulum could swing swiftly with Trump’s subsequent remarks, potentially reigniting concerns about protectionism. It’s not a fertile trending dollar landscape.Even some of the sharpest yen traders I know were left scratching their heads trying to decipher the Bank of Japan’s recent policy moves—it’s been like trying to read tea leaves for them. For me, though, it was clear cut: They managed to ‘thread the needle’ perfectly, leading to an almost instant stabilization of volatility in USDJPY. So, it ended up being a sell JPY on the crosses day, particularly against the EUR, as risk sentiment was holding up.We entered the BoJ meeting with the yen at 156, and here we are, still right around that mark. This was likely the Bank of Japan’s intended outcome, especially given the uncertainty around what is still bound to be a tumultuous currency climate under President Trump’s administration. By nudging rates upward, the BoJ has likely dodged Trump’s usual accusations of currency manipulation—at least for now. Japan often avoids too much conflict in this area, thanks to its significant investments in the US heartland and substantial Treasury holdings.There’s no need to start fires where none are needed.Looking ahead to next week, my trading decisions will largely revolve around evaluating whether the USD’s initial weakness can persist. Given the likelihood of tariffs still looming, which would ultimately support the dollar, I’m inclined to think that any current softness might be short-lived. Therefore, I’m considering adding positions in USDCNH and going short on EURUSD, ready to leverage the carry trade if immediate gains aren’t forthcoming.As for the yen, Governor Ueda’s recent comments reflect a growing confidence within the Bank of Japan about achieving its inflation targets, which might lead to further rate hikes. My main hesitation in going long on the yen stems from the potential for sudden tariff announcements that could drive U.S. 10-year yields back towards 4.75%, potentially pushing USDJPY to retest the 158 level. Aside from day trading to capitalize on the interday range, given the current tariff policy uncertainties, I don’t see a compelling eight-week position trade in my favourite currency pair.
BONDSFresh off the rollercoaster of a pandemic shock and a subsequent inflation spike, the US economy is charting a course through calmer waters. Anchored by robust growth and lingering inflation, the economic landscape echoes the vibrancy of the pre-financial crisis era. As political and trade winds swirl, the financial terrain is steadying, marked by a notable upward shift in neutral interest rates—a stark departure from the subdued levels seen in the decade following the GFC.Market dynamics now reflect a nuanced perspective. Less than 50 basis points of Federal Reserve easing are expected this year.I’ve been bearish on rate forecasts this year, yet I find myself recalibrating due to the potential softening of tariff implementations. However, the core of my bearish view remains still built around the inflationary impact of tariffs and looming budget deficits. Among my colleagues, there’s intense discussion regarding how significantly tariffs could inflate U.S. prices. Despite varying opinions on the degree, there’s a consensus that tariffs will likely exert upward pressure on consumer prices. This is especially concerning against the backdrop of the U.S.’s stubbornly high core inflation rate, just above 3%, amidst robust economic growth.Looking towards next Wednesday’s FOMC decision, the complex mix of rising inflation risks and substantial U.S. budget deficits might lead the Fed to maintain a steady rate stance, resisting President Trump’s pressure for cuts. Although Fed Waller has sounded notably dovish—an angle I often align with—this time, I maintain a hawkish stance on the 3-month SOFR rate positioning for 1.5 cuts into the second half of the year, where the first cuts will probably not commence until June. While this scenario may bolster the dollar, it’s not ideal for stocks.
STOCKSThe recent surge in stock market valuations has been underpinned primarily by unwavering growth and robust earnings. Yet, valuations have also stretched, with the S&P 500’s forward-year earnings multiple hovering around 22×, aligning the earnings yield at 4.5% closely with current 10-year Treasury yields. This landscape mirrors the 2003-07 era when 10-year yields averaged 4.4%, and forward earnings yields were more generous at 6.4%.Today’s higher valuations are evident in the equity risk premium, which resembles the 1990s, when stocks were priced somewhat richly against the backdrop of growth, inflation, and Treasury yield fundamentals. While not reaching extremes, these valuations tip toward the pricier side unless we see economic growth sustainably exceeding 3%. This scenario underscores market optimism tinged with caution as investors navigate a landscape of hearty valuations buffeted by historical echoes and future uncertainties.
NUTS & BOLTSPresident Trump’s inauguration heralded a whirlwind of executive orders, dramatically veering away from his predecessor’s policies with a bold, clear-cut agenda. These sweeping directives encompassed critical areas such as immigration, energy, climate, and trade, revoking nearly 80 previous executive actions and starkly reshaping national priorities.The immigration orders, in particular, are poised to send shockwaves through the economy. In California, the fallout is predicted to be severe, with potential for acute shortages of construction and agricultural workers. This labour squeeze could catapult food and construction costs skyward and severely hamper rebuilding efforts in wildfire-devastated regions of Los Angeles. Signs of escalating food inflation are already emerging, a situation that these new policies may further exacerbate. Trump’s aggressive pivot is set to ripple across the economic landscape, highlighting the profound and immediate impacts of his administration’s bold legislative moves.In a bold reversal of previous environmental commitments, the new administration has made sweeping changes to the nation’s energy and environmental policies. President Trump pulled the United States out of the Paris Agreement, declared a national energy emergency, and granted himself expansive powers to bypass existing environmental regulations. This aggressive shift facilitates rapid permitting for mining and drilling projects, reignites offshore drilling in federal waters, and dismantles recent motor vehicle emissions standards.The administration didn’t stop there; it also slashed energy-efficiency mandates for household appliances like dishwashers and shower heads and opened Alaska’s pristine wilderness to increased oil and gas extraction. On the regulatory front, it has initiated comprehensive reviews of LNG export terminals. It scrutinizes all federal regulations that hinder the use of major energy sources, including coal, oil, natural gas, and nuclear power. This sweeping deregulation reflects a stark pivot toward bolstering energy independence, with significant implications for environmental and regulatory policies.While President Trump refrained from immediately imposing the anticipated tariffs on major trading partners this week, he set a clear timeline for significant trade measures. On inauguration night, he announced that starting February 1, a 25% import tariff would be levied on products from Canada and Mexico, along with an additional 10% tariff on Chinese goods. Should these tariffs persist for a year, they’re expected to boost core PCE inflation nearly a percentage point higher than current projections, potentially pushing it back over the 3.0% mark and undoing recent stabilization efforts.Trump’s executive actions in trade have been robust: he mandated federal agencies to initiate comprehensive investigations into trade practices, persistent deficits, and alleged unfair currency manipulations, all considering national security and economic impacts. Specifically, the agencies are to review the adherence of China, Mexico, and Canada to the 2020 trade agreements, including the USMCA. Moreover, Trump has proposed the establishment of an External Revenue Service tasked with tariff and duties collection and initiated a thorough review of the U.S. industrial and manufacturing sectors to determine if additional national security-related tariffs are necessary. These directives underscore a strategic, albeit aggressive, recalibration of U.S. trade policies under Trump’s renewed administration.
CHART OF THE WEEKThe ‘Goldilocks’ US job marketAs Donald Trump was sworn in this week as the 47th president of the US, the country’s economy is “in the sweet spot of healthy growth and gradual disinflation,” writes Goldman Sachs Research’s Chief Economist Jan Hatzius. The team estimates that real (inflation-adjusted) GDP grew 2.6% in the fourth quarter, and they expect a similar pace of expansion in 2025. Jan Hatzius from Goldman Sachs describes the current job market with a “Goldilocks flavor,” indicating that it’s balanced enough not to risk overheating. He characterizes it as a “low-hiring / low-firing” environment, suggesting stability rather than turbulence. Goldman Sachs Research has developed a composite measure of labor market tightness, which includes factors like unemployment, job openings, quits, and perceptions of market conditions by firms and workers. This measure has stabilized at a level that is below what was observed during the 2018-2019 period when inflation hovered just below the Federal Reserve’s target. Hatzius notes that given the 1.5-2% productivity trend observed over the past five years, the deceleration of wage inflation into the 3.5-4% range aligns well with maintaining a 2% price inflation rate, supporting a balanced economic approach without excessive pressure on inflation.More By This Author:The Spotlight Shift’s From Washington To Tokyo
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