Financial Markets
3 February

Piers Bolger
Chief Investment Officer
Financial Markets – 3 February

Trade Conflict
While financial markets managed to push higher despite the events of the weekend, President Trump’s decision to implement new tariffs against the United States’ two largest trading partners, Canada and China, starting from Tuesday this week, has set the stage for a destabilizing and, in our view, ultimately destructive trade war. This trade conflict poses significant risks to the outlook for sustained global economic growth, while also affecting the downward trend in inflation. Additionally, it is likely to shift the focus of central banks toward adopting a higher “neutral” cash rate position.

Tariffs
The United States has announced a 25% tariff on all goods imported from Canada and Mexico, with the exception of copper (at least for now) and some Canadian energy products that are essential for U.S. manufacturing. In response, both Canada and Mexico have already indicated that they will implement retaliatory measures. Meanwhile, China will face tariffs at a lower rate of 10%. However, the overall economic impact on China may be mitigated due to its ability to continue devaluing the renminbi (RMB), which would help absorb much of the tariff burden through currency adjustments.

Global Supply Chain
For Canada and Mexico, the ability to manage their currency values in a similar manner is more constrained. Given that nearly 30% of all U.S. imports originate from these two countries, the new tariffs have the potential to significantly impact global economic growth and international trade dynamics. The downside risks to global supply chains are considerable. Major U.S. industry groups, such as the automotive sector, have already begun calling for a reassessment of the policy. We expect these voices of concern to grow louder the longer these trade restrictions remain in place and the broader their effects become.

The US
For financial markets, the Federal Reserve’s decision to keep interest rates unchanged is likely to be extended, particularly if inflationary pressures increase. This would hold true even if the U.S. labor market, which has experienced a remarkable post-COVID recovery, continues to perform well. The recent decline in the Australian dollar (-2.1% week-over-week) underscores the risks associated with rising U.S. interest rates. This week, the U.S. economic calendar will focus on key indicators, including the Institute for Supply Management (ISM) index, the Purchasing Managers’ Index (PMI), and labor market data. These reports are expected to show continued economic resilience.

China
In China, the upcoming release of PMI data, along with inflation indicators such as the Consumer Price Index (CPI) and the Producer Price Index (PPI), will be closely watched for any signs of a shift away from the prevailing deflationary trend, which has been suppressing domestic demand.

Australia
On the domestic front, economic data remains relatively limited, although reports on household spending and retail sales will provide insight into consumer expenditures. However, with the February corporate earnings reporting season beginning, financial markets will primarily be focused on company earnings results and outlook statements, which will be key to shaping near-term trading conditions.

 

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