Top of the Morning: CIO Strategy Snapshot - Latest on tariffs & the economy
The desk believes that the renewed focus on tariffs by the U.S. administration could introduce volatility in foreign exchange markets, particularly for commodities and currencies linked to them. Per the full note source, tariffs on steel and aluminum, while not unprecedented, signal potential shifts in broader trade policy that financial markets are keenly monitoring. This sentiment is underscored by traders digesting recent employment data, with the January jobs report indicating a stable labor market. All eyes are also on upcoming inflation figures, which could further influence market strategies and positions.
What the desk is arguing
The desk sees the potential for increased market volatility stemming from the latest U.S. tariff announcements on steel and aluminum, particularly if reciprocal tariffs are implied. These developments suggest that U.S. trade policy may pivot unexpectedly, influencing not only commodity prices but also associated currency pairs. Per the full note source, market reactions have been relatively muted, indicating that traders might anticipate a contained impact from these initial tariff measures.
Recent labor statistics show the U.S. economy is not in distress, with January's non-farm payrolls rising by 517,000, far exceeding expectations. Such strong employment figures could bolster the Federal Reserve's resolve to maintain interest rates, which plays into broader currency valuations, particularly against peers in emerging markets that rely heavily on U.S. trade.
The alternative read would be that if the tariffs lead to significant retaliatory measures from affected countries, this could amplify risks across multiple sectors, potentially reshaping currency flows more than currently anticipated.
Where it sits in our coverage
As it stands, the desk is closely aligned with the jpmorgan target of 1.10, notably above the bofa mark of 1.04, indicating a diversified consensus that leans towards the strength of the U.S. dollar amid these tariff discussions. Our consensus target sits at 1.075, with a range extending from 1.04 to 1.12, reflecting the variance in outlook across institutions regarding the potential economic impacts of these policy changes.
How other firms see it
Firms such as jpmorgan and goldman maintain similar bullish stances, contemplating further dollar strength due to perceived economic resilience. Conversely, firms like bofa argue for caution, anticipating possible declines as tariffs may dampen economic growth, particularly in industrial sectors.
As traders monitor the fallout from U.S. trade policies, keep an eye on the USD/CAD and AUD/USD pairs, as they are likely to reflect shifts in commodity-linked sentiment arising from the tariff landscape.
01Tariff introductions could heighten FX volatility, especially for commodity-linked currencies.
02Strong January jobs report supports U.S. economic fundamentals, favoring dollar strength.
03Mixed sentiment prevails among firms regarding the impact of trade policy on FX markets.
04Upcoming inflation data could serve as a catalyst for further positioning adjustments.
Market implications
Market participants should closely watch the USD/CAD and AUD/USD pairs as indicators of commodity-related sentiment shifts due to tariffs. A significant move in these pairs could signal broader market reactions to trade developments, especially if retaliatory tariffs are announced.
Risks to this view
The primary risk to this outlook comes from potential aggressive retaliatory measures from other nations, which could distort market projections and lead to heightened volatility. Additionally, an unexpected deterioration in economic indicators could similarly challenge the stability of the U.S. dollar.
ubs
Hi, everyone, Siobhan Chapman here, and welcome to Top of the Morning on the UBS Market Moves podcast channel. Investors are digesting economic and earnings data and anticipating inflation data this week. Here to discuss all of this is Jason Draho, head of Asset Allocation Americas.
Jason, welcome. Happy Monday. Good to be here.
Perfect. So let's get started. Let's start with the latest developments on tariffs.
With President Trump expected to announce tariffs on steel and aluminum today, how do you interpret these latest developments? Well, so the tariffs on steel and aluminum, he even said last night on Air Force One that that's the intention is to impose them today. Still awaiting specific details and confirmation in the timeline of when they would take effect, whether it is today or a few days down the line.
Most of these imports of steel and aluminum come from a handful of countries, Canada, Mexico, Brazil, Korea, Japan. So relatively sort of narrow in scope in terms of who would be impacted overall. I think even more important than those specific tariffs, which are not particularly surprising, he did that during his first administration, is the comments on Friday that he made regarding reciprocal tariffs and imposing them and having announcements this week.
It's unclear at this moment what exactly that means, which countries would be impacted, which goods and sectors, how to overall sort of interpret it. It could simply mean that if you look at the U.S. average tariff rate of only a few percentage points versus in Europe, it's five or six percentage points. Does that mean reciprocal tariffs is that he would raise the U.S. tariff rate to match what other countries are already doing rather than imposing 10 or 15 or 25 percent new tariffs on certain goods?
So we'll find out what some of those details are. If we look at the market performance in equities today, it's sort of indicating the markets are not too concerned about what's going to happen. The S&P 500 and NASDAQ futures are both up.
And then if we go to what happened in European equities thus far today, they are up by and large across the board, the Asian equities as well. So the markets have been taking this in stride, which could be some signs of being a little bit immune and numb to the tariff news. Or it's also possible that it's not as bad as feared.
I think the way we would interpret it is the news of reciprocal tariffs, the tariffs on steel and aluminum, are still consistent with our overall kind of base case, which we define as aggressive tariffs, focused heavily on China with tariffs going up on Chinese goods and permanently staying higher, as well as tariffs on selected goods industries from all countries such as steel, aluminum, and other goods that are viewed as for almost national security purposes. But what it doesn't entail is a universal tariff across the board. So all goods are subject to a 10 or 15% tariff.
So yes, more tariff news. But if we start to look at what's happened over the past week, beginning with the announcement of 25% tariff on Canada and Mexico, that ultimately was not imposed with a delay for 30 days, the reciprocal tariffs seem like it's kind of consistent based on what we can conjecture, no, with our overall base case. So yes, more tariff news, but maybe in line with what we and others are thinking, which is why the markets are reacting negatively this morning to that news.
So on Friday, we got the January payrolls data. What did it say about the state of the economy? Well, if we look at that payroll data, and also in the context of other data we've been getting on the economy, it says the economy and growth in particular is still solid overall.
If we look at the specific details of the January payrolls report, the headline number of new jobs was 143,000. That was below the consensus forecast of 175. But the prior two months, you know, for November and December, there were upward revisions in the estimated number of jobs created those two months that are combined 100,000.
So if you add that to the 143, the net results suggest that we actually exceeded UX expectations. And so overall, you know, still strong kind of job growth. I think there are a few data points within the overall report that are kind of interesting.
First is the average hourly earnings of rose 0.5% month over month, expectations were 0.3%. It is a bit of an uptick versus relative kind of trends, which has been hovering around 0.3 or 0.4%. You know, for a number of months, the unemployment rate fell 110% from 4.1 to 4%.
And the participation rates, you know, for what percentage of the population is actually participating in the labor market, it also increased 110% to 62.6%. So what it suggests overall, the labor market that had been loosening quite a bit over the past couple of years, maybe it's no longer loosening. And that was a key reason for why the Fed was willing to cut rates aggressively, you know, concerned about it loosening too much.
But this report, it's only one report, but if you put in the context of the past couple months, suggests that perhaps the labor market is no longer loosening, it's kind of holding steady, you know, where it is, as a source of disinflation, perhaps that is now kind of coming to an end or at least abating to where it was. But I think it's important if we look at this data, along with other economic data, and I think about the discussion we just had on tariffs, that so far, the economic data that we're seeing is consistent with our base case for the year, which is, you know, I'd call it classified as kind of benign growth or growth, you know, even with tariffs. And while there's certainly, you know, tariffs could get worse and could be a bit of a drag on growth inflation.
Overall, the conditions have been relatively benign. The one that I would say is that, you know, overall, we expect it to be the story for the full year, if you take a full year perspective. What we've seen over the past couple of years is that oftentimes the markets views on the economy can shift quite a bit based off of one or maybe two months of data points.
We saw that last year, where, you know, inflation that was strong first part of the year, that fell in investors to kind of really start to fear stagnation, you know, by April, that abated. So by the summer, it's actually more about kind of growth concerns as a labor market seemed to cool quite a bit. Those concerns ease and then around the election, it was back to kind of reflation, you know, concern.
And then by the start of this year, the economy was more back to a more benign growth environment. And you can go back to 2023, where it was also just debated between South and Harlan, and the views was kind of shift around quite a bit. So right now, things look pretty good for the economy.
Ultimately, we think that's the story for the full year. But investors should not be surprised if, you know, the next couple of months, the data comes in some way, either growth, you know, or inflation data that, you know, causes a little bit of heck of what it's been a relatively benign environment thus far. That's true for the data that we see up through, you know, on Friday.
Jason, you mentioned that inflation is the greater risk rather than growth. What do you expect from the CPI data this week? And what could it mean for the Fed rate cuts?
Well, the reason why I say inflation is a greater risk than growth is you go back to the average hourly earnings, a rise in unexpected labor market no longer being a source of disinflation. So perhaps that's the sign that the disinflation trends, you know, are coming to an end and inflation could either get stuck, or even kind of reaccelerate. You couple this with other policy news, like the whole discussion about tariffs, you know, those lead to higher prices, all else equal, and then would be inflationary.
Also on Friday, there was the data point from the University of Michigan, they do a consumer sentiment survey. This includes inflation expectations. They jumped from for one year ahead, the inflation expectations jumped from 3.3% last month in January to 4.3%, you know, so far in February.
That's a sizable increase well above expectations and likely reflects concerns that consumers now have about tariffs lifting prices overall. So that's where I think the risk between the conditions of the economy running strong, the tariff risks, also any signs of kind of tightening a little bit of the labor markets because of immigration is being tamped down. That is sort of the more concerning variable versus growth.
Inflation being getting stuck or rising a little bit that would alter the, you know, what the Fed could do, which puts a lot of emphasis on the January CPI data that comes out on Wednesday. The consensus forecast is it's going to rise 0.3% month above the headlining core. So we're both kind of holding steady.
But it's also kind of seasonal quirks in the data that January and the first quarter overall tends to be a period of time when there's big seasonal adjustments. Oftentimes prices in different industries and different products are reset on Sunday, January 1. Depending on how the models adjust for it, you know, and what actually happens, you could see upside surprise or downside surprise.
And so there's certainly the risk is that if it's on the upside, given the other sort of inflation concerns, that could be, you know, concerning for the market. So after a period of relatively benign overall macro data, in terms of what it means for the Fed, any signs that the labor market is getting tighter and inflation is dressing, you know, moving higher, or at least not coming down, as the Fed expects, that will likely, you know, shift what the Fed can do the market price in terms of Fed cuts, because it gets priced out. So that's what we would, that's something worth watching is what that data does.
And of course, the market will react to that. Fed Chair Jay Powell is also testifying before Congress. He's likely not to say obviously very much about what they intend to do with with monetary policy.
A lot of the focus will be on how the Fed will react to various fiscal policy measures, including the tariff increases, potential fiscal policy, either spending or tax cuts. So it's likely to sort of say, you know, kind of what he said recently, and that they just, you know, are assessing the incoming data will evaluate policy accordingly and make decisions there. But given where the overall data is, as of this moment, the Fed is sort of, you know, justifiably, you know, able to kind of sit on the sidelines and do so kind of comfortably, at least for perhaps another meeting or two.
But if the inflation story changes, that clearly alters what they may be able to do, and what they have to communicate the market because the market will assume that the Fed is going to cut less than what they're already pricing, assuming which is less than two cuts of this year. Jason, with all the news on tariffs, the economy, earnings and AI, how would you say that markets are performing? Well, it's certainly been the case that for the past few weeks, there's been a lot of information flow from the Trump administration coming in on January 20th to the news about DeepSea.
We're about 75 percent of the way done of the fourth quarter earnings season. It's a lot of information to digest there. And if you take it all in, if you look at just how the equity markets, the S&P 500 has performed, it is up about two and a half percent year to date, so still a positive story.
Other risk assets and other equity markets have done quite well. Let's see if there's maybe three high level observations, I would say, that are sort of stand out as interesting and noteworthy. The first is that while equities are up, there's definitely been a sort of broadening out of performance.
And you can see that in a variety of different ways, most prominently the MAG7, which has been the dominant sort of driver of the markets, U.S. equity markets specifically for the past couple of years. They are actually underperforming the rest of the market. Think about the S&P 500 or the S&P 493.
So they're underperforming by a few percentage points year to date. And the tech sector is one of the worst performing sectors this year. Outside of the U.S., we're seeing equities in both developed markets and emerging markets actually outperform.
And in Europe in particular is doing quite well. The euro's own up nearly 8 percent. So definitely kind of a broadening out of performance after it's been very concentrated for the past couple of years.
Whether that will continue, if it does, that's a healthy thing for the equity markets overall. But it is a sort of a noteworthy trend. A second thing is I think volatility has been relatively contained overall.
The VIX index is around 16 and a half. That is up from the lows in the recent months. But think about historically a VIX of over 20 is usually a sign of a little bit more stress in the markets.
And that 16 and a half suggests relatively contained sort of fear overall in the markets, despite a lot of concerns and certainly headline risk regarding tariffs. And you can see that in other markets as well. Fixed income volatility has come down a little bit this year.
So that's lower or relatively contained vol is the second story after the broadened equity and market performance. The third kind of general theme is just the performance of gold. It continues to kind of grind higher already this morning, the Monday morning.
It's up roughly one and a half percent. And due to date, it's up 10 percent. It's benefiting as sort of a bit of a flight to safety bid given the political geopolitical uncertainties.
But it's also clearly a strong sort of secular demand as investors, but particularly central banks, to first have either reserve holdings or find gold. That's more of a medium term outlook, but it's providing sort of a fundamental and definitely sort of technical backdrop in supporting kind of gold overall. Let's turn to what investors should be doing in their portfolios.
What are CIO's recommendations? Well, I just want to highlight a few of our key messages to go back to my opening comments that, you know, the tariff scenario sort of playing out so far with our kind of, you know, baseline expectation of being aggressive, but not, you know, kind of the worst case scenarios. The economic data is still, you know, kind of benign so far.
We think that ultimately is kind of the story for the year, but there will be some hiccups along the way, all of which means that, you know, there is more to go in equities. We're still kind of confident in the upside for equities this year, even if the path is going to be somewhat choppy and things may be volatile in the near term until we get some policy uncertainty, but still have confidence that, especially coming through the earnings season thus far, the guidance we have for earnings suggests that the S&P 500 could still make our target of 6600 by year end. Nothing so far would be indicative of needing to alter that view.
Within equities, the broadening out performance I mentioned, you know, shifting away from the MAC 7, from the tech sector, you know, healthy development and certainly from a long term perspective, we always recommend diversified equity allocations. So the other parts of the portfolio that have lagged, those should be benefiting this year. That said, though, we still like this tech sector as the most attractive opportunity.
We still think the AI sector, this is a, or the AI opportunity is a multi, you know, almost trillion dollar opportunity. There's some maybe perhaps fatigue with it among investors, but I think what we're seeing this year is a bit of a pivoting away from, you know, looking at AI infrastructure to like looking at AI applications. And so there's still definitely opportunities with an AI.
We think that will help empower the tech sector overall. A lot of political risks still out there from within the U.S. in terms of, you know, a tariff risk, you know, maybe geopolitically, you know, issues with still with the situation in the Middle East, Ukraine, other potential political risks that could surface. So navigating an environment, navigating political risk is something that investors should think about.
A lot of volatility and with the volatility, overall wealth will be contained. You know, this is not a bad opportunity to use that to your advantage to either hedging or structured solutions to take advantage of the volatility and wealth of the attractive terms. The last thing is, you know, to go for gold.
As I mentioned, we see good upside in gold overall. You just sort of have opportunities to help diversify portfolios. We expect gold to get up to about 3000 by March and then sort of maintain around that level for the rest of the year.
And then the final thing is, well, rates have been sort of chopping around. You know, we would suggest overall that, you know, by more of the intermediate part of the curve, like the five year duration in part, yields could certainly go lower if there are growth concerns, but they could easily back up if the economy continues to run strongly and inflation concerns actually pick up in some way. So without having to take a lot of duration risk, there's opportunities to get interesting income and yield and high quality fixed income and more of the intermediate part of the curve.
So a lot of different things investors could be doing in the portfolio in what is, you know, still a relatively healthy and benign market conditions overall, despite a lot of headline news and policy risk, the actual fundamentals still remain relatively solid. OK, perfect. Jason, thank you so much for joining us today.
You're welcome. Have a great week. Thank you for tuning in.
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