By Jamie McGeever
ORLANDO, Florida (Reuters) – TRADING DAY
Making sense of the forces driving global markets
Investors breathed a sigh of relief on Wednesday after U.S. inflation figures for February came in below forecasts, triggering a rebound in the S&P 500 and Nasdaq from six-month lows that should help put global markets on a firm footing on Thursday.
The CPI inflation report overshadowed the latest ‘tit for tat’ twist in the global trade war – U.S. President Donald Trump said he would slap further tariffs on European Union goods after the EU and other U.S. trading partners said they would retaliate for trade barriers already erected by the U.S. president.
“Whatever they charge us, we’re charging them,” Trump said.
The question now is, how much juice does this bounce have?
Today’s Key Market Moves.
Earlier on Wednesday Japanese wholesale inflation for February came in at 4.0% thanks to buoyant raw material costs. Also in Japan, wage negotiations across major firms in the process of concluding point to another year of substantial – in some cases, record – pay increases.
All this keeps alive expectations of a near-term interest rate hike by the Bank of Japan, and the 10-year JGB yield crept higher on Wednesday, close to Monday’s 16-year high.
One central bank definitely not hiking rates is the Bank of Canada, which lowered its key policy rate by 25 basis points on Wednesday to 2.75%, the seventh consecutive cut in nine months.
But the easing cycle could end soon, with Trump’s trade war threatening to lift inflation – “a new crisis,” as BOC Governor Tiff Macklem put it.
Meanwhile, Wall Street’s rebound on Wednesday could extend further because some short term technical and momentum indicators suggest the selloff is overdone. Truist’s Keith Lerner, for example, points out that the ‘Relative Strength Index’ for the S&P 500 has just moved into ‘oversold’ territory for the first time since October 2023.
But the forces bearing down on consumer, business and investor confidence, economic activity and risk appetite are too great to be fully lifted any time soon. Especially as Trump shows no sign of backing down.
U.S. airline Delta and retail giant Walmart opened a window into what we might expect to see more of in upcoming company earnings and economic data, warning that the unusually high level of economic uncertainty will impact the bottom line.
This may extend the rotation out of Wall Street into European or Asian stocks, but a sharp U.S. economic slowdown or recession would ultimately be bad news for the rest of the world too. What then for investors?
For the Fed, an economic slump would usually be met with lower interest rates. But when the root of the slump is inflationary tariffs, its response is far less clear cut.
Tariffs could tie Fed’s hands if growth slumps
With the U.S. growth outlook darkening, it’s no wonder the Federal Reserve is expected to come to the rescue and start cutting interest rates again, perhaps as soon as May.
But one of the main causes of the incoming economic storm is tariffs, and that could make Chair Jerome Powell’s job a lot less straightforward.
Cutting rates makes sense if the looming downturn is of the traditional variety, meaning it’s accompanied by a decline in inflation as demand, spending and investment all cool.
But ‘traditional’ is not a word that springs to mind when assessing the current environment. President Donald Trump’s ‘on again, off again’ tariff fights with America’s biggest trading partners has the potential to both tank growth and boost inflation.
True, policymakers were able to breathe a collective sigh of relief on Wednesday when inflation data showed consumer prices rose less than expected last month. But it may be a temporary reprieve because the inflation pass through from tariffs has yet to be felt.
If the catalyst for an economic downturn is inflationary, the Fed’s typical toolkit suddenly becomes much less effective. As economists at Morgan Stanley put it, “increased tariff intensity” puts the Fed in a “difficult spot.”
Of course, if push comes to the shove and a severe downturn occurs or market turmoil ensues, the Fed probably will cut rates – even if inflation remains above its 2% target. But the prospect of stuttering growth and sticky prices – so-called ‘stagflation’ – hugely complicates that calculus, as mollifying one problem could make the other worse.
PAUSE INTO 2026?
Tariff proponents insist duties aren’t inflationary. Consumers can buy domestic goods instead, and in the longer run, exchange rate appreciation and a narrowing trade deficit will cap prices. Or so the argument goes.
But most economists disagree and say tariffs are ultimately passed on to consumers. In theory, tariffs raise the price level permanently but only push up the inflation rate temporarily, assuming inflation expectations don’t rise too.
Fed officials maintain expectations remain well-anchored, but consumers appear to feel differently. The University of Michigan’s latest survey showed one-year inflation expectations jumping to 4.3% from 3.3%, and over the next five years households see inflation at 3.5%. That’s the highest since 1995.
Michael Pearce at Oxford Economics says rising long-term inflation expectations due to tariffs would be an issue for the Fed. “If the spike in February inflation expectations sticks, the Fed could delay rate cuts through the middle of next year, rather than resuming them later this year,” he wrote on Monday.
Jan Hatzius and his team at Goldman Sachs expect core PCE inflation to reaccelerate this year to 3.0%, nearly half a percentage point higher than they’d previously expected. Inflation at 3.0%, a full percentage point above target, would be hard for many Fed officials to stomach.
Another complicating factor is the dollar. It started this year at its strongest level in decades, but all its gains from the post-election ‘Trump bump’ have evaporated. Downside momentum is building, and further weakness would just add fuel to the inflation fire.
TREAD CAREFULLY
Right now, on balance, the economic environment indicates that further easing is likely. Demand, as evidenced by consumer spending indicators, is cooling, business and consumer confidence is falling, the stock market has dropped from all-time highs, and growth this year is now expected to be below trend.
But with inflation still hovering closer to 3% than 2% and Trump’s trade war just heating up, the Fed will need to tread carefully.
It won’t need reminding of how the bond market reacted the last time the Fed was perceived to be underestimating inflation. When the Fed cut rates by more than expected last fall long-dated Treasuries sold off and yields surged over 100 basis points in relatively short order.
So slowing growth may warrant lower rates, but that risks triggering another selloff at the long end of the bond market – a classic rock and a hard place that Fed officials might find themselves stuck between soon.
What could move markets tomorrow?
If you have more time to read today, here are a few articles I recommend to help you make sense of what happened in markets today.
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(By Jamie McGeever, editing by Deepa Babington)
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