Tariff Fatigue and Hidden PPI Optimism
Investors experienced a volatile trading session yesterday, with inflation data and trade-related headlines driving price fluctuations across asset classes. The US President has ordered a review of reciprocal tariffs, aiming to address trade imbalances through country-specific levies. The final outcome is expected by 1 April, raising concerns about potential retaliatory measures and prolonged trade uncertainty.
Meanwhile, January’s Producer Price Index (PPI) came in higher than expected, briefly stoking inflation fears. However, key components feeding into the Federal Reserve’s preferred Personal Consumption Expenditures (PCE) index showed declines in areas such as healthcare services and airfares, shifting focus to the upcoming PCE release on 28 February. US government bond yields fell across the curve by nearly the same magnitude they had risen following the Consumer Price Index (CPI) surprise. Equities moved higher in response.
The US dollar continued its decline for a third consecutive day, weakening against all G10 currencies on Thursday. This reflects two key dynamics: (1) investors remain highly sensitive to inflation data as they gauge the trajectory of price pressures, and (2) foreign exchange markets are displaying signs of fatigue regarding tariff-related news.
While Trump’s trade rhetoric and tariff policies will remain major market drivers, investors are becoming more discerning in their reactions. Given Trump’s history of shifting positions on key trade issues, markets are now responding with a more measured approach rather than overreacting to every development.
Euro Gains 1.3% This Week
The euro has strengthened for three consecutive days against the US dollar, breaking above $1.04 and marking a new high for February, solidifying its breakout above the 20-day moving average. After several failed attempts to sustain gains earlier in the week, the pair appears to have made a decisive move, shifting the short-term bias to the upside.
The evolving tariff narrative continues to keep currency traders engaged. However, the delayed implementation of tariffs has allowed the euro to advance this week, a move further boosted by constructive developments in the Russia-Ukraine conflict, despite European and Ukrainian officials reportedly being excluded from negotiations thus far. Nonetheless, bullish momentum for the euro may start to wane if the pair fails to close the week above $1.0450. The outlook for the single currency remains fragile due to weak Eurozone economic performance and firm expectations that the European Central Bank (ECB) will extend its monetary easing cycle, with inflationary pressures expected to sustainably return to the 2% target by year-end.
From a technical standpoint, $1.05 is emerging as the next key resistance level. On the downside, the 20- and 50-day moving averages may now serve as support, but if the pair falls back below $1.0350, the risk of a steeper decline increases, particularly given the lingering negative drivers weighing on the euro.
Digging into the GDP Figures
Sterling’s positive reaction to the UK’s stronger-than-expected GDP figures was short-lived, as the bigger takeaway is that the economy remains stuck in a low-growth trap—an ongoing challenge for both the Treasury and the Bank of England (BoE). That said, GBP/USD has held above its 50-day moving average and remained above $1.25, supported by US dollar weakness amid positive tariff and geopolitical news.
The UK ranked mid-table for growth among G7 nations at the end of last year, outperforming its European counterparts and avoiding a technical recession. Growth was driven by strength in the services and construction sectors, although the manufacturing sector remains in recession. However, a closer look at the data reveals that the primary driver behind the 0.1% expansion in the final quarter of 2024 was a surge in inventories, with businesses stockpiling raw materials and components. These figures tend to be highly volatile, while more telling indicators such as household consumption, exports, and business investment were all flat or negative. Notably, business investment contracted by 3.2%, and the production sector shrank for a fifth consecutive period—both indicators of underlying weakness that could dampen hiring and wage growth. This could also reinforce the disinflationary trend, which may keep the BoE on its easing path—providing a tailwind for gilts but a headwind for sterling.
The BoE expects economic weakness to persist into 2025 and recently halved its growth forecast for this year to 0.7%. Dovish members of the Monetary Policy Committee are increasingly concerned that a slowdown necessitates more substantial rate cuts. Next week’s UK inflation report will offer further insights. While the January figures may not reflect it, upside risks to inflation are growing in the coming months due to the sharp rally in natural gas prices and adjustments to UK energy and water bills.
