Trump starts the trade war

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• Trump slaps tariffs on Mexico, Canada, and China

• Tariffs could drag down growth in all four economies

• Fed holds rates steady as inflation stays elevated

• ECB cuts another 25bps, stays on autopilot

• Gold hits another all-time high

Let’s dissect

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Markets Snapshot

Trade War

• US : President Donald J. Trump is imposing additional tariffs of 25% on imports from Canada and Mexico and 10% on imports from China, with Canadian energy resources facing a lower 10% tariff. In an executive order posted on the White House website, Trump cited the International Emergency Economic Powers Act, a 1970s-era law granting the president broad tariff authority in national emergencies. The tariffs fulfill his warning to these countries over what he claims is their failure to curb undocumented migration and illegal drug flows, though he had hinted at potential relief if Canada and Mexico took action to address his concerns.

• Canada and Mexico swiftly announced retaliatory measures, escalating a trade conflict that could reshape global supply chains. Canadian Prime Minister Justin Trudeau pledged to impose 25% tariffs on C$155 billion ($106 billion) worth of U.S. goods, while Mexican President Claudia Sheinbaum also vowed countermeasures. China, in response to the 10% tariff on its products, promised “corresponding countermeasures” but did not immediately specify any new tariffs. President Xi Jinping’s administration has been treading cautiously in recent months, avoiding retaliatory trade actions that could further escalate tensions with Washington.

• According to Bloomberg Economics, Trump's tariff hikes will push the average U.S. tariff rate up from nearly 3% to 10.7%, delivering a significant supply shock to the domestic economy. The U.S. GDP is projected to contract by 1.2%, while core inflation could rise by 0.7%. The impact on Canada’s economy might be even harsher - reduction in a real GDP growth by 2 to 4 percentage points.

Macro and Fixed Income Markets

• Meanwhile, The Federal Reserve concluded its first meeting of 2025 on Wednesday, keeping its policy rate steady at 4.25% to 4.50%, as widely expected. In its post-meeting statement, the Fed noted that U.S. economic activity “has continued to expand at a solid pace,” while “labor market conditions remain solid” and inflation “remains somewhat elevated.”

• During a press conference, Fed Chair Jerome Powell stated that the Fed does “not need to be in a hurry to adjust” its policy stance and that it would require “real progress” on inflation or signs of labor market weakness before making another rate cut, indicating that rates are likely to remain unchanged at the next meeting. Markets now price in only one 25bps rate cut with a 90% probability by the end of the year.

• On Friday, the Commerce Department’s release of its core personal consumption expenditures (PCE) price index appeared to support the Fed’s assessment of elevated inflation. According to the report, core PCE—the Fed’s preferred measure of inflation—rose 2.8% year-over-year in December, holding steady for the third consecutive month after increasing from 2.7% in September. The overall PCE inflation rose at an annual rate of 2.6% in December, up from 2.4% the previous month. The Fed’s long-term core PCE target remains 2%.

• In another news, the U.S. economy remained firmly in growth mode toward the end of 2024, although the fourth quarter’s GDP figure came in slightly below most economists’ expectations. GDP expanded at an annual rate of 2.3% in the period, capping a year in which the economy recorded a 2.8% full-year growth rate, slightly below 2023’s 2.9% figure.

• The monthly jobs report set for release on Friday will reveal whether the labor market’s recent strength continued into January. The economy added 212,000 jobs in November, while December’s figure climbed to 256,000. In comparison, October saw a modest gain of just 43,000 jobs.

• EU: As expected, the ECB lowered its key deposit rate by 25 basis points to 2.75%. ECB President Christine Lagarde stated that the disinflation process was “well on track” and that the decision was unanimous. She emphasized that policy remains “restrictive,” adding, “we are not at the neutral rate.” Lagarde refrained from providing guidance on the pace of future cuts, noting that “it would be premature at this point in time to talk about the point where we have to stop.”

• Economic data showed that the eurozone economy stalled in the fourth quarter of 2024 compared to the previous quarter, missing consensus expectations for 0.1% growth. However, full-year GDP growth of 0.7% aligned with the ECB’s forecast.

• Among the bloc’s largest economies, Germany and France contracted in the fourth quarter, while Italy’s GDP was flat. Spain, however, posted 0.8% growth.

• Inflation trends varied across the region. The EU-harmonized annual inflation rate for January stood at 1.8% in France, remained at 2.8% in Germany, and rose to 2.9% in Spain.

• Canada: The Bank of Canada reduced interest rates by 0.25 percentage points but chose not to provide any forward guidance on future rate changes. The decision was influenced by uncertainty surrounding potential U.S. tariffs on Canadian goodsю In the absence of tariffs, the central bank projected steady economic growth alongside inflation remaining near its 2% target. However, it warned that widespread and substantial tariffs could challenge Canada’s economic resilience. The language ultimately proved prudent, as Trump imposed a 25% tariff on Canadian imports just days later.

Equity Markets

• US: The S&P 500 and NASDAQ increased by 1.2% and 2%, respectively, while the Dow posted a lower gain below 1% in a volatile week. The market opened on a weak note, with technology stocks dragging broader indexes lower on Monday following concerns about a competitive threat from a Chinese AI startup DeepSeek to U.S. AI companies, including OpenAI.

• Despite the rocky start, major U.S. indexes ended January with gains, rebounding after the S&P 500 and Dow closed 2024 on a negative note. The Dow rose over 4% for the month, the S&P 500 gained nearly 3%, and the NASDAQ finished about 2% higher.

• Corporate earnings continued to surpass expectations, with fourth-quarter net income on pace for the fastest growth in three years. As of Friday, earnings were projected to rise 13.2% year-over-year, outperforming the earlier forecast of 11.8% set before the reporting season began.

Commodities

• Gold: Prices climbed more than 1% for the week, surpassing the previous record high set three months earlier. On Friday, the metal traded above $2,800 per ounce for the first time, reaching approximately $2,830 in the afternoon. A year ago, gold was trading just above $2,000 per ounce, surging by more than 40% on annual basis.

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• Brussels vows ‘firm’ response to threatened Trump tariffs as EU braces for trade war (Politico)