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Growth Scare

by | Mar 3, 2025 | Uncategorized

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Month to Date Relative Performance

The Japanese yen was the top-performing currency in February, appreciating by 3.05% due to a combination of rising Japanese interest rates and a decline in U.S. 10-year interest rates.

Month to Date Relative Performance

As illustrated in the chart above, the USD weakened against the yen, dropping from approximately 159 in early January to around 148.55 by the last week of February—its lowest level since October. This yen strength is attributed to expectations that the Bank of Japan will continue normalizing monetary policy following decades of negative interest rates. Japan’s January CPI stood at 4%, surpassing the U.S. inflation rate of 3%—a phenomenon last observed in 1997-1998. While market surveys indicate a preference for a July interest rate hike, the swaps market does not fully price in the next increase until early Q4.

Conversely, the New Zealand dollar was the weakest among major currencies in February. The Reserve Bank of New Zealand lowered its benchmark interest rate by 50 basis points to 3.75% in an effort to stimulate the economy amid moderating inflation. Governor Adrian Orr signaled the likelihood of further rate cuts, projecting a decline to approximately 3% by year-end.

Turning to the USD Index—a measure of the dollar against a basket of major currencies—it surged nearly 10% between late September and mid-January, peaking on January 13, just a week before President Trump’s inauguration. However, profit-taking ensued, and despite indications in early February that 25% tariffs on Canada and Mexico were imminent, the index failed to reach new highs. The index subsequently declined by about 3.6% from its January peak as markets perceived the tariffs as a negotiating tactic.

Month to Date Relative Performance

As February came to an end, Trump reaffirmed his intention to impose the 25% tariff on Mexico and Canada (excluding energy), introduced an additional 10% tariff on China, and signaled the possibility of further tariffs on the EU and specific industries—such as steel, aluminum, copper, autos, semiconductors, pharmaceuticals, and lumber. Consequently, the USD Index rebounded, ending the month on a strong note and hitting a two-week high on the final trading day.

It is important to highlight that, among all the tariff announcements and threats—including the 25% tariffs on Canada and Mexico for border issues (migration and fentanyl), 25% tariffs on steel and aluminum imports, reciprocal tariffs on Europe, and potential auto tariffs—the only tariff actually imposed thus far has been the additional 10% levy on all imports from China and Hong Kong.
A survey by 22V Research indicates no clear consensus on the likelihood of the Mexico and Canada tariffs taking effect next week. The median estimate places the odds at 50%, but responses are evenly distributed above and below this threshold, reflecting uncertainty. This uncertainty is exacerbated by mixed messaging. While Trump has repeatedly framed the tariffs as a response to fentanyl trafficking, he has also suggested they relate to trade deficits, implying a potential renegotiation of the USMCA trade agreement. A recent Bloomberg report hinted at a possible resolution, noting that Mexico was open to tariffs on China to avoid U.S. duties. Hours later, Treasury Secretary Bessent stated that Mexico’s proposal to match U.S. tariffs on China was “very interesting” and suggested that a similar move from Canada would be a “nice gesture.” This suggests that Canada might avoid tariffs if it agrees to impose duties on Chinese imports. The situation is expected to become clearer by Sunday or Monday. In the final week of February, concerns over economic growth intensified. A sharp decline in the Philadelphia Fed’s non-manufacturing activity survey, coupled with a steep drop in the Conference Board’s consumer confidence index, triggered a fall in U.S. bond yields. Further fueling these concerns, the Atlanta Fed’s GDP tracker warned of a potential 1.5% contraction in Q1, a significant shift from its mid-February estimate of 2.3% annualized growth. These developments predate the full implementation of tariffs (except those on China) and the anticipated large-scale federal government layoffs. All of this raises the question: does a “Trump put” still exist? During his first term, Trump frequently touted stock market gains, but since returning to office, he appears less concerned. Would a market downturn prompt him to reconsider his tariff strategy, as it seemingly did in late 2018? While the answer remains uncertain, there is a clear rationale for his tariff pressure. With the Federal Reserve unwilling to lower interest rates, Trump appears to be leveraging economic uncertainty—driven by tariff threats—to indirectly compel rate cuts. The early Q1 GDP contraction reinforces this strategy, working in his favor.
Amid all the tariff discussions, an equally significant development has largely been overshadowed. The U.S. government will reach its debt ceiling on March 15. This could potentially result in a government shutdown, with its economic impact depending on both the scope and duration of the impasse. Historically, the federal government has only been shut down for more than one business day on four occasions. Notably, during Trump’s first term—despite a Republican majority in both houses—Congress failed to reach a budget agreement, resulting in a record 35-day government shutdown from late 2018 into early 2019.