JPMorgan Plans US$4b US Gold Delivery Amid Tariff Fears

Market exuberance about the US growth outlook has pushed up interest rates and the US dollar, as has the stance of US fiscal policy. But can high interest rates and a seemingly overvalued exchange rate be compatible with ‘US exceptionalism’?

If one ever needed confirmation that financial markets price things primarily based on beliefs about the future, this week gave it. Once it became clear that, no, President Trump was not going to enact sweeping tariffs by executive order on Day 1, the ‘Trump trade’ and ‘American exceptionalism’ drivers of pricing reversed somewhat. The US dollar depreciated, bond yields declined and US share prices slipped. The Australian dollar bounced about three-quarters of a cent against the US dollar in the space of a few hours. These moves did not entirely undo the shifts seen since the US election, but they highlighted just how overbought the Trump trade was. People trade the belief, and then reverse course when reality turns out differently. (And then reverse course again on some actual announcements, but that’s another story.)

The deeper question of the future path of US interest rates remains.

Contrary to last year’s recession worries, US economic growth remains well above past assessments of trend. Unemployment remains low and employment growth robust. Inflation has declined but remains sticky above the Federal Reserve’s 2% target. Compared with other major advanced economies, the United States has been remarkably resilient to tight monetary policy. The US economy has powered along almost as if the fed funds rate had not been so high.

This resilience has been a bit of a puzzle. Low fixed-rate mortgages have long been a factor there, so they cannot fully explain this divergence. Macroeconomic statistics being what they are, one can never completely rule out ‘it was all a mirage and will be revised away eventually’ as an explanation. Stronger balance sheets in the wake of the policy support during the pandemic may be contributing. Also relevant, though, is the role of fiscal policy working in the opposite direction to monetary policy. This is a theme we have highlighted previously.

Conventional macro analysis tells you that it’s the change in the fiscal deficit – sometimes called the ‘fiscal impulse’ – that contributes to economic growth. That said, the level of the deficit surely matters for the level of output, and thus any assessment of how demand and supply compare. And at more than 5% of GDP, the US federal deficit is helping to supercharge demand in an already fully employed US economy. By contrast, because burgeoning public spending in Australia is being more or less matched by rising taxation, the boost to the level of overall demand is smaller.

At this scale, differences in fiscal stance can influence the paths of monetary policy interest rates. In broad terms, the narrative for the last couple of years has been that central banks needed to set monetary policy to be restrictive to get inflation back down to target. Once they were reasonably sure that the disinflation was on track, central banks would start cutting interest rates back towards neutral, wherever that was. Because monetary policy works with a lag, this process needs to start before inflation has returned all the way back to target.

The idea that monetary policy needs to become less restrictive as inflation approaches target remains intact. Less clear, though, is whether interest rates need to converge to ‘neutral’ (r* in the economics jargon) in the short term, or to some other rate.

Where policy rates end up troughing in different economies over the next year or so therefore rests on the answer to two questions.

First, how does the (long-run) neutral rate relate to the central bank’s estimates of it?

It has long been our house view that, wherever neutral is, it is higher than it used to be. The Federal Reserve and other central banks have seen the same developments and revised up their estimates of neutral over the past year or so. Based on the ‘dot plot’ of FOMC members’ views on the ‘long-run’ level of rates, the Fed’s estimates of neutral are centred on 3% or a touch below. This is still a little below our own view that this longer-run concept of neutral is likely to be somewhere in the low to mid 3s.

Depending on how quickly central banks pivot their thinking, it is therefore possible that some central banks will need to backtrack as they discover that the neutral rate they were aiming for is actually higher than they thought. This evolution, and the likely policy actions of the Trump administration, underpin our current forecast that the Fed will start raising rates again in 2026. Policymakers never forecast that they will end up backtracking, so the ‘dot plot’ shows a smoother convergence without a turning point. But it’s also plausible that the smoother path implied by the ‘dot plot’ occurs because policymakers revise up their estimate of neutral further.

(We don’t think the RBA is subject to the same risk of upward revision to their estimates of neutral in the near term. Their models already imply that the neutral nominal cash rate is in the mid 3s, and the recently adopted checklist approach to assessing broader monetary conditions will reduce the risk that statistical inertia in those models leads to underestimates of neutral.)

Second, is long-run ‘neutral’ where monetary policy needs to converge to, or is there something (like fiscal policy) that monetary policy will end up needing to lean against to keep inflation at target?

One could argue that this is making a distinction without a difference: those forces are just the things that cause ‘true r*’ to move around. The issue is that the standard models used by central banks to estimate the neutral rate do not include the impetus from fiscal policy or other factors over which monetary policy has no direct influence. The researchers in this field acknowledge that persistent changes in fiscal policy could affect the level of neutral. But because their models omit any fiscal variables, they cannot quantify the effect.

Despite these shortcomings in the models, FOMC members clearly recognise the issue. The ‘dot plot’ shows that they do not expect the fed funds rate to reach ‘neutral’ until after 2027. So even if their view on neutral is still too low, their recognition that other factors lean against a swift return to neutral will help counterbalance this.

Because other major economies have different fiscal (and growth) outlooks, the shifting market view on US rates has implied shifts in views on interest rate differentials, and so exchange rates. But this puts the US dollar even further above levels at which purchasing powers are at parity, an anchor point that exchange rates tend to gravitate towards over a run of years. Most published measures of the real effective US dollar exchange rate show it at levels surpassed only by the mid-1980s era that ended in the Plaza Accord.

Higher interest rates and a seemingly overvalued exchange rate. One can’t help thinking that reality will bite the US exceptionalism narrative sooner or later.

Source: ACTIONFOREX

Treasury and foreign exchange

But what should one watch out for?

What options are available to Treasury and the administration?

What are the possible outs?

Sources:OMFIF

The BoJ upgraded its inflation outlook to above 2% throughout the forecast period

The BoJ's rate hike itself was already fully priced into the market, so it came as no surprise. But the Bank's latest quarterly outlook report sent a clearer message that further rate hikes would come sooner than the market had expected. The BoJ expects inflation to remain above 2% until FY2026. Governor Kazuo Ueda's communication at the press conference was rather ambiguous about the timing of the next rate hike and the terminal rate, but this was somewhat expected. Governor Ueda reiterated that the real interest rate remains negative, and monetary conditions therefore remain accommodative. Thus the market appears to be more closely following the projection of the sustainable inflation outlook.

The BoJ upgraded its inflation outlook quite sharply

Source: CEIC

Solid wage growth underpins broad-based inflation gains

The December inflation results are mostly in line with market consensus. Inflation jumped to 3.6% year-on-year in December (vs 2.9% in November, market consensus 3.4%) mainly due to a pick up in utilities (11.4%) and fresh food prices (17.3%). Higher utilities are mainly due to the end of the government subsidy programme. Rice prices continued to rise sharply which will lead to service prices (eating out) rising with a time lag, thus the BoJ should be watching the price trend carefully.

Core inflation excluding fresh food also rose to 3.0% (vs 2.7% in November, 3.0% market consensus) while core-core inflation excluding fresh food and energy stayed at 2.4% (vs 2.4% in November, market consensus). In the monthly comparison, inflation growth accelerated to 0.6% month-on-month seasonally-adjusted (vs 0.4% in November) with goods and services up by 1.1% and 0.1% each. Apart from the end of energy subsidies and rising fresh food prices, service prices are rising steadily, which in our view is more important than the rise in headline inflation.

Service prices rose steadily

Source: CEIC

BoJ watch

Governor Ueda's comments made clear that the Bank is not in a hurry to raise rates again. But we noted that his optimistic view on the outlook for spring wage negotiations is a signal that a May hike option is on the table. For the May hike to materialise, Shunto's results would need to be as strong as last year's, which is our base case scenario.

We expect inflation to cool down from January as the government renews its energy subsidy programme, but rising rice prices are likely to have a second-round effect in pushing up broader services prices.

If another solid wage negotiation and steady rise in service prices are confirmed, we expect another 25bp hike in May.

One of the major risk factors is President Trump's trade policy. So far Trump's trade policy has been mostly in line with market consensus and there has been no particular negative news for Japan. But, this may change in the future, and the BoJ's rate hike may be delayed.

JPY: Positive news, but US yields remain the key driver

As markets perceived the upward revision in inflation forecasts as a hawkish signal, there seems to be a bit more tailwind for the yen. Remember USD/JPY still has room to unwind extensive long positioning and the dollar has continued to lose momentum since Trump’s inauguration as the threat of imminent tariffs is decreasing.

Two-year JPY swap rates have risen by only 3bp to 0.74% after the BoJ announcement, which signals there is more room for a hawkish repricing in the curve in the coming months if we are correct with our expectations for two more hikes in 2025. That bodes well for the yen, which however remains heavily dependent on the impact of Trump policies on US Treasury yields.

Our rates team retains a bearish call UST which makes us reluctant to switch to a downward-sloping profile for USD/JPY just yet. That said, should upside room for US yields end up proving limited, the case for USD/JPY to move to the 155-150 range this year becomes quite compelling given the relatively hawkish BoJ and still significant medium-term overvaluation of the pair.

Source: ING

Source: Manufacturing Today

The Korean economy posted weaker-than-expected growth last year amid slowing export growth, sagging domestic demand and a political crisis.

The economic expansion in the fourth quarter also came far below the earlier forecast by the Bank of Korea (BOK) as political turmoil sparked by President Yoon Suk Yeol's shocking martial law declaration dented private spending and investment, according to the central bank.

The country's real gross domestic product — a key measure of economic growth — increased 2 percent in 2024, according to preliminary data from the BOK.

The 2024 figure was lower than the central bank's forecast of a 2.2 percent expansion, though the growth accelerated from a 1.4 percent advance in 2023.

Last year's growth was led by exports, which surged 6.9 percent from a year earlier, compared with a 3.5 percent on-year increase in 2023.

Private spending rose 1.1 percent in 2024, slower than a 1.8 percent growth the previous year.

Facility investment gained 1.8 percent, while construction investment fell 2.7 percent.

In the fourth quarter alone, Asia's fourth-largest economy advanced 0.1 percent on-quarter, far lower than the BOK's forecast of a 0.4 percent growth.

On a yearly basis, the economy grew 1.2 percent in the fourth quarter, slowing from the previous quarter's 1.5 percent gain.

Exports inched up 0.3 percent from three months earlier in the fourth quarter, while imports shed 0.1 percent.

Private consumption added 0.2 percent on-quarter, and government spending rose 0.5 percent. Facility investment also climbed 1.6 percent.

But construction investment dropped 3.2 percent, the data showed.

"Heightened political uncertainties affected consumer sentiment and private spending. The situation of the construction industry was worse than expected," BOK official Shin Seung-cheol told a press briefing.

Yoon declared a shocking martial law on Dec. 3, and the National Assembly voted to impeach him.

Yoon was arrested earlier this month and has come under investigation on charges of leading an insurrection and committing abuse of power.

Korea had been on an economic recovery track at the beginning of 2024, but momentum has weakened as the growth of exports has slowed and domestic demand remained in the doldrums.

The economy expanded 1.3 percent from three months earlier in the first quarter but contracted 0.2 percent in the second quarter before barely growing 0.1 percent in the third quarter.

The BOK earlier presented a 1.9 percent growth outlook for the Korean economy in 2025, which is widely expected to be lowered further.

"Weak domestic demand and the construction industry slump are expected to continue through the first quarter of this year," Shin said, citing a potential extra budget and policy changes under the new Donald Trump administration as major factors that will affect the economy down the road. (Yonhap)

Source: Koreatimes

Fed holds rates steady at 4.25-4.5%

No surprises from the Federal Reserve at today’s FOMC meeting with a unanimous decision to leave the Fed funds target range at 4.25-4.5%. After 100bp of cuts through the final four months of 2024 the Fed had already signalled a desire to take time to evaluate the impact of their actions and to also gain greater clarity on how President Trump’s policy thrust may impact the economy.

That said, within the accompanying statement there is a hawkish shift in language that suggests we need to see an unambiguous softening in the data for them to deliver further interest rate cuts. It repeats that economic expansion remains “solid”, but they have removed the comment that inflation has “made progress” towards the 2% target, saying merely that “inflation remains somewhat elevated” – although in the press conference Chair Powell downplayed the significance of this. They also state that unemployment has “stabilised” with labour market conditions “solid”. In December they said that labour market conditions had “generally eased”.

Fed funds target rate and market expectations

Source: Macrobond, Bloomberg, ING

President Trump wants lower interest rates

The Fed will no doubt be braced for criticism from President Trump who told last week’s Davos World Economic Forum that “with oil prices going down, I'll demand that interest rates drop immediately, and likewise they should be dropping all over the world”. The Fed under Jay Powell, whose term expires next year, will only acquiesce if to do so would be consistent with their mandate. Their December forecasts do indicate an inclination to cut interest rates – they are projecting two cuts this year – but their concern is likely to be that Donald Trump’s policy thrust of tax cuts and less regulation should be growth supportive while tariffs and immigration controls are likely to be somewhat inflationary. With tomorrow’s GDP data expected to show the economy grew 2.8% last year and with unemployment a little above 4% and core inflation lingering around 3% the Fed are likely to pause here for a number of months. This was confirmed by Chair Powell in the press conference when he said "we do not need to be in a hurry to adjust out policy stance".

Slower and more gradual moves from the Fed

Our forecast had been three Federal Reserve interest rate cuts in 2025 – March, June and September – but this was heavily dependent on President Trump’s enacted policies as well as the evolution of data. We remain optimistic on a further moderation in annual inflation rates in the months ahead, helped by slowing housing cost increases. We also anticipate that next month’s payrolls benchmark revisions will indicate a much weaker job creation path than initially reported. However, with Donald Trump threatening 25% tariffs on Mexico and Canada and 10% on China from this weekend the narrative could rapidly change – indeed Powell admits "we don't know what will happen with tariffs, with immigration, with fiscal policy, with regulatory policy". But in an environment of renewed Fed wariness we are leaning in the direction of a slower rate cutting path of two 25bp rate cuts in the second half of 2025 with a further 25bp cut in early 2026 while acknowledging that the range of possible outcomes is, if anything, widening.

Treasuries eye issues with rate cut ambition, while QT end not made an issue just yet

It’s clear that inflation is still an issue at the Fed. Not as severe as it was, but let’s say, not a fully resolved issue. Treasuries have had the same view over recent months. This is a 3% inflation economy, and therein lies the genesis of the funds rate not getting back down to neutral (3%) and the 10yr Treasury yield remaining above 4.5%. The impulse reaction for Treasuries is negative due to this. We’re not fully convinced this is the beginning of resumed bear market just yet, as we have the PCE inflation report this week. The worry will be that the Fed has seen it, and maybe is not thrilled by it. If so, that’s not great for Treasuries.

On the likely end to QT by mid year (our view), the short FOMC statement chose not to mention it. Maybe not big for them now. But they certainly must have talked about it. The issue here is excess liquidity (which we define as bank reserves plus reverse repo balances). It is likely to hit levels that the Fed would prefer not to go below from the middle of 2025 onwards, partly depending on how the debt ceiling saga evolves. The key number here is US$3tn for bank reserves, representing about 10% of GDP. We are currently at US$3.3tn. However, with QT running at US$60bn per month, ongoing QT would bring reserves down in net terms. The Fed will want to end QT before things get overly tight.

But clearly the Fed did not want to make a big deal on the end of QT, as it will end. Rather the "no change" outcome is smothered by inflation stubbornness, although in the end smoothed over by another ever-calm Chair Powell performance.

Dollar gets a brief lift

A mildly hawkish FOMC statement has seen the dollar take its cue from the USD rates market and edge a little higher. This in no way compares to December’s big shift in Fed communication and projections which helped propel the DXY dollar index to a high of 110 in early January. And in fact, those modest dollar gains have proved fleeting today.

Instead, the FX market will probably take a little more interest in Friday’s release of the December core PCE inflation release and a lot more interest in whether the weekend sees the Trump administration follow-through on threats to impose tariffs on Canada, Mexico and China.

In particular, in its Monetary Policy Report released today, the Bank of Canada has tried to model the impact of a 25% US tariff on all Canadian goods and retaliatory Canadian tariffs by the same amount. The conclusion is that Canadian growth would be 2.5% below baseline forecasts in Year 1, while the inflationary impact would see CPI being a full 1% above baseline forecasts by Year 3.

Importantly, a separate research article in that publication estimates that of the 7% rise in USD/CAD since October, 6% of that rise has been driven by a risk premium. In other words, and we agree, the threat of tariffs has been a major driver of FX rates and that will probably be the case as FX markets await trade developments this weekend. And if not this weekend, uncertainty around findings of a major US trade review in April looks likely to keep the dollar bid over coming months.

In short, tariffs and not rate differentials are the major FX driver now. But a slightly hawkish Fed can only help a market currently positioned overweight the dollar.

Source: ING