Overview:
With President Trump’s announced tariff plans proving far more aggressive than markets had been pricing ahead of the weekend, a recalibration of valuations is now underway as investors readjust risk premia and re-evaluate the baseline outlook. The major supply shock represented by the new trade barriers will likely add to inflation, weaken GDP and trade, and probably lead to greater divergence in interest rates between the US, Europe and other major markets. (An early independent assessment on the impact on the US economy, from the Budget Lab at Yale, can be found here.) And that is being reflected at the start of the weak in lower equity prices, a stronger dollar, weaker US Treasuries particularly at the shorter end of the curve, but gains in Bunds and Gilts. JGBs, however, were remarkably stable, except at the super-long end of the curve.

Against that backdrop, over coming days, markets will continue to respond to the following:

* First and foremost, the ongoing news-flow on US trade policy could well bring further twists and turns. After separate calls with the Canadian and Mexican leadership today, the 25% tariffs with the US’s two neighbours (with the exception of a 10% tariff on Canadian energy exports), as well as an additional 10% tariff on imports from China, are scheduled to take effect on Tuesday. Assuming they are implemented as announced, countermeasures from the three countries – with Canada’s plan for a first round of 25% tariffs on a range of items already announced – will follow. But so too might further retaliatory measures from the US. And Trump’s utterances on his intentions for tariffs on imports from other major manufacturing regions, not least Europe and Japan, will clearly have a market impact too.

* The BoE’s policy announcement (Thursday) will bring a further cut of 25bps – the third so far this cycle – taking Bank Rate to 4.50%. As in November, we expect eight of the nine MPC members to vote for the cut, with only the external hawk Mann preferring no change. The rate cut will be justified by the updated projections, which will significantly downgrade the GDP growth outlook to reflect the recent flatlining of economic output and tightening of financial conditions. So, while the inflation outlook for this year will be revised up, we expect it also to suggest increasing risks of undershooting the 2% target over the medium term. Given the significant increase in two-sided risks to the inflation outlook posed by political developments in the US, the MPC’s updated forward guidance should continue to point to ongoing ‘gradual’ monetary easing this year – which we interpret as representing one 25bps rate cut per quarter – and a terminal rate that is lower than currently priced by the OIS markets.

* The incoming macroeconomic data, which will focus not least on labour markets, will take a lower profile than usual. But the US jobs report (Friday) will, as ever, be a focus, with Daiwa America looking for a sub-consensus gain in nonfarm payrolls of 140k but a steady unemployment rate of 4.1%. Elsewhere, Japanese labour earnings data (Wednesday) should remain consistent with ongoing monetary policy normalisation with regular pay rising around a three-decade high. The ECB’s wage tracker data, the same day, should continue to signal the likelihood of a significant moderation in pay growth this year, which should allow euro area consumer price inflation – which ticked up to 2.5%Y/Y in January according to today’s flash estimate – to return to the 2% target this year.

* Finally, EU leaders meet for an ‘informal retreat’ in Brussels (today) to discuss how to take greater responsibility for the region’s defence, including how to finance greater capabilities, whether by mobilising private funds or drawing from the EU budget. A working dinner with UK PM Starmer at the same event will seek to reset the post-Brexit relationship to become more constructive with respect to defence and security, crime and – bringing us back full circle – to trade.

Day-by-day key economic data & macroeconomic events

Today:
The flash estimates of euro area inflation in January came in a touch firmer than expected on the back of a larger uptick in Italy (up 0.3ppt to 1.7%Y/Y). In particular, the euro area headline HICP rate rose 0.1ppt to a six-month high of 2.5%Y/Y. But this reflected a significant jump in energy inflation to a near-two-year high. In contrast, non-energy industrial goods inflation was steady at a still-subdued 0.5%Y/Y, while services inflation edged slightly lower to 3.9%Y/Y. Overall, the core HICP rate was unchanged at 2.7%Y/Y for a fifth successive month. In the US, the manufacturing ISM is expected to signal some stabilisation in the sector at the start of the year, consistent with modest improvements in various regional Fed surveys. But the headline index might still be merely consistent with zero production growth even ahead of Trump’s tariff announcements. The employment component – which has signalled ongoing job cuts in the sector – will be watched ahead of Friday’s payrolls report. Meanwhile, after reaching agreement with lawmakers at the end of last week. the French government is expected to present the 2025 state budget to the national assembly today, which subsequently will be passed without a vote by invoking article 49.3 of the Constitution. PM Bayrou has also signalled his intention to push the social security budget through parliament the same way. That will risk a first vote of no confidence in his administration. However, unlike the vote that brought an end to Barnier’s short term as PM before Christmas, the current government appear to have greater chance of survival this time around.

Tomorrow:
While the implementation (or not) of US tariffs on imports from Mexico, Canada and China will be the main focus, ahead of the payrolls report, US job openings and labour turnover (JOLTS) data are likely to show that job openings declined modestly in December after ticking slightly higher in November to maintain the steady downtrend in place since spring 2022.

Wednesday:
In the US, the headline services ISM index is expected to have held steady in January at 54.1, consistent with still solid expansion in the sector. The employment ISM is likely to remain consistent with modest jobs growth, while the prices paid component – which jumped to a near-two-year high in December – will be watched for evidence of inflation persistence in the sector at the start of the year. In the euro area, ECB Chief Economist Lane’s fireside chat at the Peterson Institute for International Economics will be watched for insights into the potential impact of US tariffs on the euro area economic outlook and how the ECB might respond. Meanwhile, the ECB’s wage tracker should continue to point towards a moderation in wage growth, which should allow euro area consumer price inflation to return to target over coming quarters. In Japan, average wage growth in December is expected to have slowed only slightly from November’s near-two-year high (3.9%Y/Y), with regular pay growth of full-time employees forecast to remain close to 3.0%Y/Y.

Thursday:
Attention will be on the BoE’s policy announcement and updated macroeconomic projections. In line with the market consensus, we expect the MPC to cut Bank Rate by a further 25bps to 4.50%, to mark the third such reduction this easing cycle, and take Bank Rate to a 20-month low. As in November, we expect eight of the nine MPC members to vote for the cut, with only the external hawk Mann preferring no change. The rate cut will be justified by the Bank’s updated projections, which will downgrade the GDP growth outlook. But while the near-term inflation outlook will likely be revised up, in part due to the weakening in sterling and higher energy prices, the projections should also suggest that inflation still risks undershooting the 2% target over the medium term in part due to excessively tight financial conditions (see Friday’s Euro wrap-up for further details). Of course, these projections will not include the impact of Trump’s aggressive tariff announcements. So, we would expect Governor Bailey to be pressed in his post-meeting press conference on the associated potential impact on the UK’s economic outlook, the balance of risks between inflation persistence and undershooting the target, and the BoE’s policy path over the near term.

In terms of economic data, euro area retail sales are expected to have declined slightly in December, in part due to German weakness and fragile consumer confidence. Nonetheless, due to a positive carry over from Q3, they should confirm a fifth consecutive quarter of positive growth in Q4. While German factory orders might partially reverse the drop in November which reflected a decline in major orders, this release seems bound to suggest that underlying demand remains weak.

Friday:
All eyes will be on the US labour market report. Daiwa America expects payroll growth to have slowed sharply in December from 256k to 140k, some 30k below the Bloomberg survey consensus and 20k below the average in 2024. The BLS’ annual benchmarking review might bring notable revisions to payrolls numbers last year. Notwithstanding slowing jobs growth, the unemployment rate is expected to hold steady at 4.1%. Meanwhile, average hourly earnings are expected to rise 0.3%M/M – a touch softer than the average in the previous six months – to leave the annual rate moderating slightly by 0.1ppt to 3.8%Y/Y. In the University of Michigan consumer sentiment survey, inflation expectations will be watched closely even though most responses will have been provided ahead of the weekend’s US tariff announcements measures. The expected rate of inflation 5-10 years’ ahead in the December survey rose to 3.2%, the joint-highest level since 2008. Data-wise, German industrial production and goods trade figures for December are likely report a decline in manufacturing output and exports at the end of 2024, to leave them down over the fourth quarter as a whole and representing a non-negligible drag on GDP in Q4. Finally, the BoJ’s consumption activity index will provide an update on household consumption in Q4 ahead of the first estimate of Japanese Q4 GDP (17 February).