Market Brief: Sentiment Remains Weak As Tariff Fears Outweigh Still-Supportive Fundamentals

Measures of risk appetite remain soft in currency markets amid mounting concern that Donald Trump’s tariffs may prove more enduring than had been hoped. A federal appeals court yesterday granted the administration a temporary reprieve from a ruling that could have unraveled much of its trade policy, broader confidence was dented by a Wall Street Journal report suggesting the White House is weighing a stopgap strategy to keep tariffs in place, and the President later posted a social media broadside against a legal system that has frustrated his ambitions in the last week. On a trade-weighted basis, the dollar remains roughly half a percentage point weaker relative to last Friday, the safe-haven Swiss franc is outperforming its risk-sensitive brethren, and the Japanese yen is climbing after Tokyo inflation posted its sharpest rise in two years, keeping the Bank of Japan on course toward a summer rate hike.

In fixed income markets, Treasury yields are essentially unchanged after new data showed underlying inflation pressures easing further in the United States last month, giving central bankers breathing room as they prepare to resume their easing cycle. Data released by the Bureau of Economic Analysis this morning showed the Federal Reserve’s preferred inflation measure – the core personal consumption expenditures index – rising 0.1 percent from the prior month, matching market forecasts, while the 3-month annualised percentage change dropped to 2.7 percent, alleviating fears of an acceleration ahead. The overall personal consumption expenditures index also rose 0.1 percent relative to the prior month, and was up 2.1 percent from a year ago, slowing from 2.2 percent previously.

Consumption data suffered a small reversal after alarmed households front-loaded major purchases earlier in the year. Personal incomes climbed 0.8 percent – accelerating from an upwardly-revised 0.7 percent in the prior month and topping market forecasts for a 0.3-percent gain, but personal spending grew just 0.2 percent, down from the 0.7-percent print recorded in March. On an inflation-adjusted basis, spending cooled to a 0.1-percent pace.

Price growth could accelerate slightly in the coming months as retailers pass cost increases along and higher stock market valuations boost portfolio management fees, but we suspect that growth risks will ultimately play a bigger role in influencing policy direction at the Federal Reserve. September remains the most likely anchor point for the next rate cut.

Here on the still-terribly-cold side of the 49th, the Canadian economy expanded by more than forecast in the first quarter, helping reduce market bets on an imminent rate cut from the Bank of Canada. Numbers released by Statistics Canada this morning showed real gross domestic product growing at a 2.2-percent annualised pace in the three months ended March, well above market expectations and the Bank of Canada’s 1.8-percent forecast. The gain was primarily driven by growth in financial, mining, and oil and gas industries, with a big jump in net exports and inventory accumulation – likely flattered by front-running efforts associated with US tariff increases – helping lift the headline print.

We hate to look the gift horse in the mouth, but underlying growth momentum remains weak. Final domestic demand – which excludes trade and inventory effects for a clearer view of underlying fundamentals – shrank -0.21% in the quarter, and an advance estimate showed overall output growing just 0.1 percent in April as modest growth in the construction, resource extraction, and sectors was partially offset by weakness in manufacturing industries – suggesting that further softness is ahead.

The odds favour a hold at next week’s Bank of Canada meeting, with officials maintaining the policy rate at 2.75 percent for now as they wait for more conclusive evidence of a sustained shift in economic direction. There is little doubt that soaring uncertainty levels have dealt a damaging blow to growth, yet core inflation – as defined using the Bank’s preferred trim and median measures – has shown signs of a durable acceleration, consumer sentiment surveys are pointing to a modest brightening in spirits, and retail sales numbers have proven surprisingly robust. This resilience may be attributable to a reappraisal of Canada’s vulnerability to US tariffs (it has escaped the brunt of Trump’s trade war thus far) and to confidence in the positive spillovers that the Carney’s government’s stimulus push could deliver – but it is also possible that the flow of credit into Canadian households unleashed by last year’s rate-cutting cycle is translating into more spending power. With the policy rate already near the estimated neutral range, we think the Bank has the flexibility to stay on the sidelines for now.

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