Foreign Exchange Commentary

Summary

• U.S. tariff threats against Canada and Mexico over last weekend triggered a short term spike higher in the U.S dollar; however, U.S. dollar has since given back those gains as those tariffs delayed to March.
• U.S.employment report came out weaker than expected but overall the U.S. jobs market is in good shape.
• On Thursday, Mexico lowered interest rates by 0.50% to 9.50% with more interest rate cuts in the pipeline.
• On Wednesday, U.K. lowered interest rates by 0.25% to 4.50% but the pace of future interest rate cuts could be slower than expected.
• China’s purchasing managers index declined by the second straight month as further evidence of a slowing economy
• German industrial production data for December fell by more than expected (-2.4% vs consensus -0.7%) as more evidence of a slowing of a German economy.

Tariffs, U.S. Employment Report, and the U.S. Dollar
Over this past weekend, the Trump administration ratcheted up steep tariff threats to Canada and Mexico triggering a sharp U.S. dollar rally in the FX markets during the early hours of the Asia FX trading session on Monday (Sunday evening in North America).

When it was announced tariffs would be delayed a month, the U.S. Dollar Index reverted back to prior levels ending the week a bit softer compared to last week.  Recognizing the U.S. tariff issue with Canada and Mexico is an evolving story, the markets were quick to factor in that so far it’s a negotiating tactic of the Trump administration.

Since end of September 2024, the U.S. Dollar Index has risen around 8.0%-9.0% with the highs for the move set in mid-January. In other words, the underlying upward momentum and the tariff drama earlier this week did not result in new highs for the current move in the U.S. Dollar Index. As more tariff related news comes to light, it will be interesting to see that impact to the trend in the U.S. dollar.

Today’s U.S. employment report came out a bit weaker than expected with non-farm payrolls rising +143,000 vs. market consensus of +175,000. According to Comerica’s Chief Economist Bill Adams, after ‘looking through a lot of noise, the jobs report shows the labor market kicked off 2025 in good shape.’  After the market had time to digest the report, after a few hours of trading U.S. 10-Year Treasury yields were higher by 0.06% while at the same time German 10-Year Treasury yields were mostly unchanged to a pinch higher. With that shift in the US-German interest rate differential, that has helped the U.S. dollar to move higher on the day.

Mexico Lowers Interest Rates
As expected, the central bank of Mexico (Banxico) lowered short-term interest rates by 0.50% to 9.50%. In the statement accompanying the decision, Banxico said ‘the Board estimates that looking forward it could continue calibrating the monetary policy stance and consider adjusting it in similar magnitudes.” Further they went on to say, they anticipate ‘the inflationary environment will allow the rate cutting cycle to continue, albeit maintaining a restrictive stance.”

According to Bloomberg News, Mexico’s annual inflation slowed to 3.69% in January which is a full percentage point lower in than in October. Since the Banxico targets inflation of 3% plus or minus 1%, this puts them on track from an inflationary perspective.

U.K Lowers Interest Rates
On Wednesday, as anticipated the Bank of England (BOE) lowered interest rates by 0.25% to 4.50%. While all nine members of the Monetary Policy Committee (MPC) voted in favor of the rate cut, it was a bit of surprise two of the members favored lowering rates by 0.50%. However, the MPC statement was interpreted by the market to a potential slower pace of rate cuts indicating that only two more rate cuts will be needed to bring inflation down to their 2.0% goal. The MPC’s Hue Pill said that interest rates will need to remain restrictive to ‘squeeze out’ any lasting inflationary pressures in the U.K. economy.