Higher inflation and cutting rates is an unhappy combination

First, a technical note: looking at most of the charts in the Chart Package, it seems like we should have several buy USD signals. That’s right, but we are delaying the decision because we don’t trust a buy USD signal at the same time global economic catastrophe might be upon us, the yield on the 10-year is falling like a rock (see the 5-day chart)

—and it can change direction again, as it did in March. In fact, the hourly charts reveal a distinct lack of momentum and a fair amount of choppiness.

Why is this happening? We suspect the yield drop has to do with folks exiting the stock market, the conventional way of looking at it. Are any of them not already holders of dollars? If so, the implication is a fresh inflow of foreign money to Treasuries as the ultimate safe haven, despite Trumpian economic irrationality. Well, maybe.

Returning to macro, even before we get hit over the head with whatever Trump is going to throw, Moody chief economist Zandi raised the Goldman forecast of a 35% chance of recession and now thinks 40% is more appropriate.

We now have a genuine fear of near-recession. Remember that today we get another Atlanta Fed GDPNow estimate for Q1, most recently at -1.4% adjusting for the gold imports.

Bloomberg’s Authers: “To some extent, the central bankers can’t be expected to adjust their outlook to the new protectionist reality, as there’s still no clarity on the magnitude and scope of tariffs. After Trump’s promised “Liberation Day,” Jerome Powell and his Federal Reserve colleagues could have to pivot swiftly. So far, though, it’s noticeable that for all the sharp rises in consumer- and market-based inflation forecasts, US rates markets appear more worried about a slowdown than inflation; projected rates have fallen far more for the Fed than for other central banks.” Well said.

What is that pivot? The implication is an early rate cut. The next policy meeting is 35 days away in early May (and nothing says the Fed can’t hold a special meeting at any time outside the formal schedule). But the CME FedWatch tool shows no interest in that date, and the bettors prefer June, where the probability of a June cut is 63.4%, up from 56.5% a month ago. The Big Banks name Sept as the first cut, but Reuters has been saying June for almost a month now.

Nobody in his right mind would try to forecast out to May, let alone June, considering the pseudo-macro we have to deal with, but by then flows to Treasuries should have slowed down. The stock market may have adapted to new conditions and stabilized. Inflation will be more visible, just as the Fed will be cutting to boost the economy generally. Higher inflation and cutting rates is an unhappy combination. This is the justification for a lousy summer for the dollar. 

But expecting stabilization under Trumpian conditions may be a pipe-dream, at least for the near-term. Bloomberg reports Wall Street trading desks expect the tariff news today and its aftermath to exacerbate the selloff, at least near-term. China has told local firms to stop investing in US companies.

This may give China some leverage in tariff talks, or not. If not, the next step would be dumping US investments (and dumping the dollar, too). When you do an internet search for “how much money does China have in US stock market,” there is no answer. (Searches like this is what passes for fun.) What about the nearly 300 Chinese companies listed in the US with a market cap of about $850 billion? At a guess, the White House has paid no attention to the knock-on effects, which is pretty dumb considering the TreasSec used to be a hedge fund manager.

Tariffs: At noon yesterday, the press was reporting that most in the Trump inner circle still did not know what the tariff decision would be. In other words, no plan. There may be tiering or there may be blanket tariffs on everything from everybody.  The big announcement event will be at 4 pm this afternoon. Reuters reports Big Pharma is lobbying hard up to the last minute to get exemptions on imported drugs. Well, we know Trump is for sale.

After the earthquake, the tsunami, meaning the retaliation by other countries. The EU seems firm on imposing the same tariffs on the US as imposed on it, with the response of others not clear. It’s possible we get few official statements as trade partners try to keep their heads down. 

We agree with Reuters’ Dolan who writes “…  the real risk is more of a slow-burning U.S. market decline on some open-ended plan - seeding months more of uncertainty rather than a cathartic one-off.”

“… And no matter what happens this week, markets are still likely to face lingering doubts about the trade war endgame and the unknowable lagged effects of the import levies on prices, demand, hiring and activity. So it's hard to see how the tariff boil gets lanced this week.

“Trump's administration retains the right to extend, hike, postpone or even cancel the tariffs as part of its high-pressure dealmaking on a range of thorny issues with both allies and rivals. And it is also impossible to know how the rest of the world will react and retaliate to the U.S. actions, a factor in the looming trade war that is often underplayed.”

Then there is the stock market. Trump pretends he doesn’t care if it’s responding badly to his mismanagement, but that can’t be true. A second giant wave of expectation adjustments will come when the earnings effect of the tariffs start getting priced into forward earnings. Some 40% of S&P company revenues are from overseas branches and sales. Information tech is the biggie, with 56% exposure to foreign markets, with “materials” at 51%. 

From yesterday and worth remembering: Trump says tariffs will raise $6 trillion, which is ridiculous. Total imports in 2024 were $4.1 trillion. Two: a takeaway from the FT article: if the US imposes a universal 25% tariff and all affected countries retaliate with the same 25%, US inflation rises to 5.5%.

Forecast

While the charts seem to point toward a stronger dollar, we are resisting changing our signals to buy USD. As noted above, a stronger dollar makes no sense except in the illogical and counter-intuitive sentiment of risk-on = safe haven dollar.

Even with macro comparisons, the US is more likely to slide into recession than is Europe, considering its new commitment to fiscal stimulus. ECR Research says the EU could even surpass the US in growth in coming quarters (zowie).

“We expect EUR/USD to gradually climb towards 1.20, and any interim corrections are unlikely to go far below 1.06.”

For the rest of the ECR Research analysis, a free trial is at https://ecrresearch.com/trial/request

Bottom line, we cannot recommend buying the dollar except on the technical basis and for the shortest possibly holding period. Be ready to jump ship at a moment’s notice.

Tidbit: The Danes (and Greenlanders) are pretty mad at the US. The Canadians have steam coming out of their ears. Their reputation for courtesy and good manners is well-earned but they know mistreatment when they see it. The boycott of American imports is widespread, along with travel to the US.

Newsweek reported yesterday that a recent poll (mid-Feb) shows 85% of the Canadian shoppers reported they will replace US products with made-in-Canada. American suppliers are clutching their heads in dismay.

So far we have 25% a tariff on everything imported from Canada, with a 10% tariff on energy. Ex-energy, Canda runs a deficit with the US. Hello? And that’s just goods, to the tune of $63.3 billion in 2024. In services, Canada may buy as much as another net $25-30 billion. Maybe the tech industry will emigrate even from sunny California to the northlands. Doe Mr. Carney have a plan?

Canadian PM Carney has a PhD in economics. Trump got a D- in Econ 101 at Wharton. (For that matter, Mexican Pres Sheinbaum has a PhD, too (engineering) and was among the scientists receiving the 2007 Nobel Prize for Peace for their work on the United Nations Intergovernmental Panel on Climate Change. Even Jimmy Carter had a degree in nuclear engineering. Boy, are we outclassed. Trump doesn’t know the difference between transgender mice and transgenic mice, and nobody in his circle has the nerve to correct him.

Tidbit: The public mood can feed macro data. In the UK, the mood has been gloomy for many years now, changes in government notwithstanding. The dreadful Farage is still around and still lying. Labour is a little less gloomy now it’s rid of that rigidly pinko Corbyn, but no better, yet, at impressing the public. In the most recent inflation data, food prices are up 2.4%. Then there are the price rises to start hitting this month in water, council tax, train fares and other public services, to the tune some £600 per household. This is only about 2% of average income (£37,430) but would buy a high-end mattress or a low-end stove. The propensity to consume must be falling, right?

Not according to the NY Fed, which jiggered its data from surveys and comes up with the counter-intuitive deductions that uncertain personal earnings raises the propensity to consume—in the US. No wonder people hate economists. 

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