Instimatch - FX morning commentary - 3/2/25

Good morning

In what is shaping up to be the first salvo of many in a likely broader and swifter trade war, President Trump hit Canada and Mexico with tariffs up to 25%, while imports from China will face a 10% tariff over and above existing US tariffs. Canadian oil and energy products will face a lower 10% levy. These tariffs were announced on 1 Feb, and will apply from 4 Feb. These measures were taken to address the issue of borders and fentanyl according to the Trump administration and includes a clause indicating possible further increases in tariffs if countries retaliate. On that note, Canada announced 25% tariffs against US$106bn of US goods including American beer, wine and bourbon, and fruits and fruit juices, together with non-tariff measures such as boycotts of American products. Mexico’s President Claudia Sheinbaum has instructed the economy minister to implement a response plan, including retaliatory tariffs, but also called for cooperation with the US. The response from China was interestingly more measured, vowing “corresponding countermeasures” without elaborating, while also pledging to file a complaint at the WTO. 

Overall, the USD remains the main beneficiary of the tariffs and will likely continue to find support amid softening sentiment as markets reprice the risks of escalating trade tensions. With tariffs dominating the narrative, US labour market data, including Friday's jobs report, could take a backseat this week.

The USD index surged about 1.3% in Asian trade to 109.51, reaching a near one-month peak. The greenback was also back in sight of an over two-year high hit in January.  The tariff escalation has triggered risk aversion this morning. Main Asian stock markets lost around 3% overnight with European and US equity futures pointing at losses of around 2.5%.  The US yield curve has flattened with the front end of the curve adding up to 5bp (higher inflation threat) and the long end losing around 2bp (hit to growth & risk aversion).

EUR/USD has dropped further to around 1.0230 from Friday's close at 1.0362, USD/CAD has traded a multi-year high just shy of 1.48 and the MXN is being hit as well.

GBP FX ended the week on a strong note with EUR/GBP moving closer to the 0.83 mark while GBP/USD falls below $1.2300 to trade around $1.2270. This week, the big event for UK markets is the Bank of England monetary policy meeting on Thursday, where traders expect a 25bp cut in line with consensus and market pricing. The vote split is expected to be 8-1 with the majority voting for a cut and hawk Catherine Mann voting for an unchanged decision. Overall, analysts expect the BoE to stick to its previous guidance noting that "a gradual approach to removing monetary policy restraint remains appropriate". The market reaction should be rather muted upon announcement with a cut fully expected by markets. 

On another note, Brexit has come into focus again with UK PM Starmer appearing at the European Council today with focus on defence and security. While any news fostering an improved EU-UK relationship would be received as positive for UK assets, it will be news on trade barriers that is in focus.

Traders await the full response by markets given how several Asian countries are still out on holidays, the path of least resistance for now is for Asian currencies and risk assets to weaken, together with a greater risk premia to account for future meaningful tariff moves beyond what we have seen. 

JPY is the only currency to keep pace with the dollar, trading broadly unchanged around USD/JPY 155.

Mainland Chinese markets remain closed for the week-long Lunar New Year holiday, with trade only set to resume tomorrow. Meanwhile, the yuan weakened to a record low in offshore trade, with the USD/CNH pair rising 0.5% to a record high of 7.3536 yuan.

Trade-exposed Asian currencies were the worst performers overnight, with USD/SGD jumping 0.8% to 1.3660, while the AUD/USD fell 1.8% to a near five-year low around 0.6137. The trade-sensitive USD/KRW surged 0.9% to 1,465.48, while the Indian rupee’s USD/INR pair rose 0.4% to a record high of 87.095 rupees. 

A key development over the weekend was the announcement of India’s Budget for FY2025/26. The government maintained a commitment to reduce the fiscal deficit to 4.4% of GDP for FY2025/26, from an estimated 4.8% in FY2024/25, and these numbers were in line with our expectations. Among several key measures, the government cut taxes for low-to-middle income households, which according to the government will likely cost it around INR1trillion (~0.3% of GDP) worth of revenues.  The announcements were viewed as broadly neutral to perhaps a marginal positive for INR, and consensus forecasts for USD/INR to rise further to 88.50 through 2025. Markets expect RBI to cut its repo rate by 25bp later this week bringing it to 6.25% from 6.50% currently.