Risk appetite is returning to global financial markets this morning as investors move to price in rate cuts and traders welcome a more conciliatory tone from the Trump administration on trade and monetary independence issues. The president and Treasury Secretary Scott Bessent both made supportive noises on trade negotiations during yesterday’s session, and a number of Federal Reserve officials highlighted downside risks in public appearances. North American stock market futures are setting up for a modestly-lower open, but the US ten-year Treasury yield is pushing lower, and the dollar is strengthening against its safe-haven alternatives in Japan, Switzerland, and the euro zone. Signs of a fundamental trend reversal remain difficult to see, but the rotation out of US equity markets appears to be stabilising.
Fed officials are telegraphing a growing easing bias. In an interview with Bloomberg Television yesterday, governor Christopher Waller suggested that he would likely “look through” import tax-led price increases, saying “I’m not going to overreact to any increase in inflation that I think is attributable to the tariffs,” indicating that these might be temporary, “But if I see a significant drop in the labor market, I think it’s important that we step in”. Cleveland president Beth Hammack later told CNBC “If we have clear and convincing data by June, then I think you’ll see the committee move,” toward cutting rates.
Investors are on the fence. Prediction-market odds on a recession in the world’s largest economy have surged in the last two months, but are still just above coin-toss levels, indicating a heightened degree of uncertainty about how the administration’s incredibly-erratic policy changes might influence activity in the real world. Swap-implied probabilities are tilted toward three rate cuts from the Fed before year end – consistent with a move toward “neutral,” but not reflective of the sort of emergency easing cycle that has historically accompanied economic downturns.
Next week’s data releases could play a major role in calibrating expectations. A torrent of corporate earnings reports and survey updates – from the Conference Board on Tuesday and the Institute for Supply Management on Thursday – will help investors understand whether early April’s sharp deterioration in soft data has proven durable, but is the hard data – first-quarter gross domestic product, the job openings and labour turnover survey, and Friday’s all-important payrolls report – that could determine overall positioning.
The Canadian dollar is holding steady after new data showed the country’s consumption engine running strong. According to Statistics Canada, overall receipts fell 0.4 percent in February but a preliminary estimate pointed to a 0.7-percent gain in March, suggesting that the end of the government’s temporary goods and services tax holiday – and the damage that has been wrought on consumer sentiment by a sharp escalation in trade tensions with the United States – failed to dampen buying activity. We doubt this will last, and would expect a reversion into negative territory in the coming months as sobering realties outweigh the desire for retail therapy among households.
Relative to other major currencies, implied volatility in the dollar-Canada pair looks well-contained ahead of Monday’s election. Mark Carney’s Liberals are the clear front-runners in a race that has turned into a referendum on Canada’s relationship with the United States, but investors are unlikely to react with hostility if Pierre Poilievre’s Conservatives – who have promised larger tax cuts and more deregulation – somehow emerge victorious. Although investors tend to react with revulsion to the sort of spending plans the Liberals are now outlining, the reality is that many would welcome an offset to the other near-term headwinds facing the Canadian economy – rising joblessness, slowing export growth, and weak investment coming on top of terrible productivity and still-spectacular levels of household indebtedness – and we don’t expect major moves in bond markets after the outcome is pronounced next week.
More broadly, we suspect that the Canadian dollar’s brief flirtation with safe-haven status is over. Unlike the euro, yen, and Swiss franc, the loonie is reverting to its role as a levered play on economic and financial conditions south of the 49th Parallel, meaning that it should climb when risk appetite improves on American markets, and should fall during flight-to-quality episodes.
Further south, the Mexican peso is also exhibiting remarkable stability. The exchange rate has risen sharply in the last month as the dollar has weakened, and on signs that President Claudia Sheinbaum’s diplomatic efforts are paying off, helping insulate the economy from the effects of Donald Trump’s trade war. Carveouts for Mexican goods have reduced the effective tariff rate to levels that make the country competitive with its counterparts in Asia — suggesting that it could increase its market share in the American import basket, and that existing investment is unlikely to leave.
But in the medium term, ties to an increasingly-beleaguered American economy could drag the exchange rate lower. With domestic demand already weakening, and exports and remittances exposed to a slowdown in activity north of the Rio Grande, the country’s growth rate looks set to slow – especially once first-quarter tariff front-running effects begin to fade. The Banxico is already hinting at more 50 basis-point cuts to come, which would narrow rate differentials relative to the US, particularly if high inflation expectations slow the Fed’s easing progress. We wouldn’t rule out a drift back through the 20 threshold for the Mexico-dollar pair at some point in the coming months.
