Risk sentiment remains key today and we continue to err on the side of caution

Market

The stars aligned for a significant risk-off correction yesterday. First and foremost, the market narrative changed since the end of last week with investors attaching a higher probability to a mid-term US recession. Especially sentiment surveys highlighted numbing uncertainty with consumers and businesses as DOGE efforts bite and as the overall policy mix risks working inflationary. A (too) restrictive monetary policy (from a growth point of view) could end up being the straw that breaks the camel’s back. In this respect, we started noting a first change of tone in some Fed speeches. Cleveland Fed Hammack said that rates are restrictive enough to lower inflation. Kansas City Fed Schmid suggested that the Fed could have to balance inflation risks against growth concerns. Philly Fed Harker thinks that the policy rate remains restrictive enough to continue putting downward pressure on inflation over the longer term. Second, tariffs have an amplifying market impact in this negative setting. The confirmation of the March 4 deadline for 25% tariffs on Mexico and Canada, the 10%pts increase on the earlier 10% on Chinese goods, the April 2 deadline for reciprocal tariffs and the first growl against Europe (“25% on autos, other things”) added to the rally in US Treasuries and weakness in stock markets. In FX space though, it sparked a turnaround in the USD’s fortunes: currencies of trading partners yesterday underperformed a USD being vulnerable to the idea of a US recession. A battle of weakness. EUR/USD slipped back below 1.04 after a failed test of first resistance at 1.0533 earlier this week. USD/CAD left YTD lows below 1.42 at the start of the week to currently change hands around 1.4450. Finally, the reigning negative risk sentiment determined the interpretation of AI-bellwether Nvidia’s Q4 earnings. Strong and a beat, but not fantastic as investor’s got used too. The stock entered the ongoing vicious spiral, correcting around 8.5% and dragging the AI- and tech-heavy Nasdaq almost 3% lower with the index losing support at 18831 (YTD low and downside of sideways trend channel since December).

Risk sentiment remains key today and we continue to err on the side of caution. Last-minute deals to fend off the 25% tariffs in Mexico and Canada are possible but risk-reward it could be more interesting to await the facts. There are asymmetric risks to US PCE deflators today with in-line or lower outcomes able to extend a continuation of trends in especially US Treasuries. German and French CPI data serve as a prelude for the EMU number on Monday and could bolster the case of an April pause in the ECB’s cutting cycle.

News and views

Tokyo February inflation eased a little more than expected in February. The headline gauge fell from 3.4% to 2.9% vs a 3.2% estimate. The central bank’s preferred measure which excludes fresh food retreated from 2.5% to 2.2% (2.3% expected). Both continue to be impacted by government subsidies that offset some of the energy costs though, masking some of the underlying price strength. CPI ex fresh food and energy matched last month’s 1.9% in a sign of ongoing steady price rises. Tokyo inflation is often seen as a good indication of the national figure’s (March 21) direction. Education subsidies in the country’s capital keeps the pace slower than in the rest of Japan, though. Other data showed Japanese industrial production tumbling 1.1% m/m. This sharp drop is partially the result of the Chinese Lunar New Year, which probably disrupted trade flows. Retail sales in Japan climbed 0.5% m/m to 3.9% y/y. The Japanese yen holds up pretty well this morning against overall USD strength after the data releases. USD/JPY trades around 150.

Bloomberg had a sneak peak in the European Council’s draft conclusions ahead of the important March 6 summit during which EU leaders will be seeking ways to finance massive - to the tune of €500bn - rearmament investments. It will call on the Commission “to propose additional funding sources for defense at EU level, including by means of additional flexibility in the use of structural funds, and to present swiftly relevant proposals,” the news agency reported. The draft text also said the Council will ask the European Investment Bank to adapt lending practices to the defense industry, noting it should re-evaluate the list of excluded activities, as well as urge the Commission to present options to use the flexibility within the fiscal rules. The latter should allow for “significant defense spending” at the national level without breaching the 3% deficit rules.

Download The Full Sunrise Market Commentary