Markets are rallying this morning on optimism surrounding the prospect of more easing from the Federal Reserve as well as the growing likelihood of trade “deals” between the United States and its partners. Yields are down across the curve as investors bet a slowing economy could give central bankers more room to cut rates and equity indices are climbing in line with hopeful statements from administration officials currently negotiating agreements with Japan, India, and other countries. The dollar is up sharply.
Data published yesterday overstated the scale of the downturn in the US economy. A massive jump in the trade deficit in the first quarter – driven by a 41.3-percent annualised surge in imports ahead of the Trump administration’s threatened tariffs – subtracted 4.8 percentage points from the growth rate, which is meant to measure the value of domestic production. In data that goes back to 1947, the economy has never seen a larger negative hit from net exports in one quarter.
Consumer spending did slow however, and markets are bracing for more softness ahead. Household consumption, which drives roughly two thirds of gross domestic product, increased at a 1.8-percent rate – the slowest since mid-2023 – and the services sector experienced a sharp deceleration as consumers pulled demand for goods forward.
Signs of softness to come are, perversely, lifting market spirits. With the Fed now seen easing more aggressively, yields are pushing lower, reducing downward pressure on asset prices and contributing to a rise in the dollar as retail investors pile in and foreign participants slow the pace of selling. This is, of course, highly unusual — the dollar has historically tended to weaken on a deterioration in rate differentials — but also seems consistent with an unwind in last month’s extreme breakdown in cross-asset correlations.
The Canadian dollar is trading with a firmer bias after President Trump yesterday noted that he had a friendly conversation with newly-minted Prime Minister Mark Carney, saying “I think we’re going to have a great relationship. He called me up yesterday, and said ‘Let’s make a deal,’” adding that his counterpart was a “very nice gentleman and he’s going to come to the White House very shortly, within the next week or less”. Data published yesterday showed the Canadian economy stagnating toward the end of the first quarter as trade uncertainty pummelled businesses and consumers, but with the victorious Liberals promising to increase government spending, lower interprovincial trade barriers, boost housing construction, and build energy infrastructure, fears of a deep recession have been allayed somewhat.
In contrast, the euro is still moving lower, suggesting that the signing of a long-telegraphed mineral deal between Ukraine and the US isn’t expected to materially reduce the geopolitical headwinds facing the common currency bloc. Kyiv and Washington yesterday agreed to establish a jointly-managed investment fund – backed by expected revenues from new resource extraction licenses – in an arrangement that the Trump administration has framed as a symbol of its commitment to Ukrainian sovereignty and a strategic move to secure returns on military aid. The pact contains no concrete security guarantee, and isn’t expected to yield significant monetary returns, given that there are no meaningful economically viable rare earth reserves in Ukraine – as Bloomberg’s brilliant Javier Blas has pointed out – and that its iron, coal, and resources are either locked behind Russian lines or are commercially available in the United States.
Japanese government bond yields are down and the yen is weaker after the Bank of Japan left rates unchanged, downgraded its growth outlook, and extended the expected timeline for achieving its 2-percent inflation target. In a widely-expected unanimous decision, the central bank maintained its benchmark policy rate at 0.5 percent, but also cut its economic growth forecast for the fiscal year ending March 2026 to 0.5 percent from 1.1 percent, and said it expects core inflation to reach target a year later than previously estimated. During the post-decision press conference, Governor Ueda said “Recent developments surrounding tariffs will weigh on Japan’s economy by slowing global growth, hurting corporate profits, and prodding households and companies to hold off on spending due to heightening uncertainties,” although ultimately, “we expect a positive cycle of rising wages and inflation to continue due to a severe labour shortage”. “It’s hard to judge now when we will see the likelihood of our scenario being achieved,” he said. “As such, we would like to take a flexible approach in our policy response”. Markets are now placing just 20-percent odds on a rate hike by year end, aligning the Bank of Japan with the downgrade in expectations that has occurred across most major economies since the start of the year.
