The Global Week Ahead: Play the Long Game on Tariffs

Next Week's Risk Dashboard

• Policy risk front and center as risks build
• Canada can’t be a pushover amid the threat of tariffs
• How Trump’s tariffs would weaken hemispheric security
• US CPI to reaffirm that the Fed is on hold
• US financials begin reporting season
• Canada’s leadership race to heat up
• BoC to deliver an update on balance sheet plans…
• …and may face the difficult question of how to manage a surge of debt issuance
• Bank of Korea expected to cut
• Bank Indonesia’s eye on the rupiah will keep it on hold
• How did the year in retail close out in the US, UK and China?
• China’s economy may have posted firmer growth
• Is Australia’s jobs juggernaut still rolling?
• Will UK core inflation register further progress?
• Global macro

Chart of the Week

Markets will probably digest a fair number of off-calendar tape bombs this week if the first full week of the new year was any indication of what to expect. It’s the last full week before President-elect Trump’s inauguration on January 20^th and the likelihood that he acts fast to deliver executive orders on numerous policy matters possibly including tariffs. It’s also a period of relative calm for decisions by major central banks until they whir to action again into month-end.

There will still be a fair number of calendar-based risks to markets though. At the top of the list of the indicator hall of fame this week will be CPI from the US, UK and India, Chinese GDP, retail sales from the US, UK and China, and Australian jobs. The only central bank decisions on the docket will be from the Bank of Korea and Bank Indonesia. US financials will also begin reporting Q4 and full year earnings.

A potentially significant speech on balance sheet management and other topics will be delivered by the Bank of Canada. The race to become the next Liberal Party leader will also heat up with Mark Carney indicating he is entering, Christy Clark (former BC Premier) leaning in that direction, and an announcement expected from Chrystia Freeland as the three main names to watch. A vote will be held on March 4^th ahead of the March 24^th reopening of Parliament, a likely confidence vote before March 31^st and a likely election in May.

HOW SHOULD CANADA RESPOND TO TRUMP’S TARIFF THREATS?

Watch for more market-sensitive headlines on policy developments particularly concerning US-driven trade tensions with Canada, Mexico, Europe, China, Denmark, the UK, Panama, Greenland and I’m sure I’ve left off a bunch of others.

Anonymous officials with the Canadian government signalled through the press this past week their strong openness toward retaliating against US tariffs if the threat should turn to reality. By the end of the week, they indicated that everything was on the table, from a selective list of retaliatory tariffs to matching US tariffs dollar for dollar and maybe even export taxes on strategic commodities such as oil, uranium and potash. Are they right to do so?

I’ll give two schools of thought on the matter and indicate where I lean on the matter.

The traditional economist response is to just take it when another country imposes trade restrictions. Don't retaliate. You'll make things worse. Tariffs on US imports into Canada will drive prices higher, squeezing purchasing power, imposing further damage on consumption, business investment, growth, unemployment, etc. An ugly situation would be made uglier. At least in the short-term, this school of thought is right about the effects. Charts 1–4 provide our estimates of the impact of across-the-board US tariffs on Canadian growth, inflation, unemployment, and the Bank of Canada’s policy rate under both no-retaliation and full retaliation scenarios.

Now go to the local playground. Spot the kid being picked on the most each and every day and who does nothing about it. That picked on kid’s gonna be an economist one day! That's what this traditional take basically says.

And it’s not what I believe, nor how I think a sovereign nation should deal with an administration like the one taking power in the US. Just taking it might be more appropriate if this is a one-off occurrence for a short time that allows CAD and other effects to adjust and then it all goes away. That’s not what I think we’re facing here.

So what to do? In a multi-sequenced game theory sense with years of this ahead of us and being played against a seemingly highly irrational regime, you have to dig in and play the longer game. If you don't stand up now, you'll get your lunch stolen from you each and every single day. Pushed down in the playground over and over. Tariffs ad nauseam and other punitive measures. It’s my belief that Trump’s zero-sum framework of thinking has established a goal that aims to destroy the attractiveness of investment in Canada for the long haul through successive punitive measures without thinking through the consequences for the US because the US administration thinks that it will get the spoils. That cannot be allowed to happen for the sake of longer-run generational prosperity.

Canada stood up in Trump 1.0 with retaliatory tariffs. Canada stood its ground in NAFTA 2.0 negotiations. Trump backed down almost entirely from his original demands and went out with a whimper as Freeland’s team competently stood its ground. It was made clear that Canada would punch back. It worked. The US electoral cycle that is in permanent election mode helped in this regard.

The stakes are far higher now. Trump 1.0 was mostly about metals tariffs and Canada retaliated with proportionate targeted tariffs starting on Canada Day and lasting until the next May. This time it’s not about just targeting Kentucky bourbon or yogurt made at a plant in Paul Ryan’s home state.

You've got to make it very, very clear to US businesses that Canada will not roll over and to raise awareness of the consequences to what is so far a checked-out US business community not using lobbying powers of influence to protect their supply chains from disruption and to protect their shareholders. Bourbon won’t cut it this time. That requires causing maximum upheaval across US supply chains and turmoil into US mid-terms, waking up US businesses, and forcing the GOP senators and representatives in all the states that declare Canada to be their #1 trade partner to explain the turmoil to voters as shifts potentially get suspended, plants shut, layoffs occur etc. The incumbent always suffers a setback into mid-terms. Make it more so this time. A lame duck President into the second half of this mandate if not before as the GOP spends 2026 on the run. Mess with Canada’s politics, and we’ll come down and mess with yours.

Then sit back and let US domestic pressure reawaken and be applied against the administration with US businesses, workers and consumers leading the charge. That’s also what happened the last time around as the US business lobby took over Washington’s hotels including Trump’s that his family is trying to pry back. Otherwise, it will be four years of this over and over and over at much greater longer-run cost to the economy and the welfare of Canadians. Make yourself someone who is easy to pick on and you'll be picked on over and over.

Strong retaliation would add to the pain of US tariffs against Canadian exports in the short-term which is hugely unfortunate and hopefully we find another way as the best option to avoid all of this. I haven’t given up all hope that a better way can be achieved if not by avoiding tariffs, then by only having them for a short period, but it’s looking more likely that the threat is larger and longer in nature. If so, then you've got to dig in and play the longer game. Mexico the same. And be prepared with a bevy of support measures ready to roll out immediately across provinces and the feds.

All of this is just my personal opinion but I’m much less convinced that the way to go is with the traditional economist's advice in this instance because of the nature of the threat and the danger of the threats becoming serial in nature at much greater long-run than short-run cost. It may be that the trade-off lies in a couple of quarters—maybe more—of economic pain in order to save the economy longer term. I also don’t think it’s politically realistic to assume that Canadian governments—federal and provincial—will not respond which makes it practical to consider the risk of bigger retaliation. They may well turn the other cheek, but not that one.

Furthermore, as argued here earlier this week, applying tariffs against Canada will arguably conflict with the Trump administration’s goal of addressing hemispheric security. Tariffs would blow out the Federal government’s deficit; in that scenario, the all-hands-on-deck crisis management would be no environment in which to raise Canadian defence spending from a paltry 1.3% of NGDP to the NATO target of 2% where it should be in living up to its commitments, and with Trump’s 5% demand being wildly unrealistic. Trump’s 5% demand would mean spending $1.5–2.0 trillion on defence over a decade for a C$3 trillion economy. Ain’t gonna happen. In fact, defence spending would be more likely to go on the chopping block if things got bad enough.

And if damage to the economy is great enough, then maybe Canada needs to re-think its openness to investment in critical minerals and other resources by regimes that don’t quite share the same values and goals as the US and Canada. The number one goal of politicians is to put bread on the electorate’s table. Out of necessity may come the need to rethink economic and geopolitical alliances which I honestly think would be an unfortunate but perhaps unavoidable outcome.

U.S. CPI—REAFFIRMING THE FED ON HOLD

The December CPI inflation report arrives on Wednesday. It’s likely just a placeholder to pass the time given strong signals from FOMC officials that they will be patient before taking further steps. That implies skipping the January decision and with markets pricing little chance of action at the March 19^th decision when fresh forecasts are delivered. A lot will happen between now and then as the new US administration takes power.

Still, if estimates are on the mark, then this report may reinforce sentiment that the FOMC is likely to remain on hold for some time. I’ve estimated headline CPI at 0.4% m/m SA and core at 0.3% which would mean that the year-over-year rates would climb to 2.9% for headline and remain at 3.3% for CPI ex-food and energy. Seasonally unadjusted gasoline prices (all grades) were down by about 1% m/m in December but that was less than seasonally normal, and so a gasoline SA factor of around 1.07 or so should translate into a decent seasonally adjusted rise in gas prices with about a 0.1% weighted contribution to headline CPI.

The Cleveland Fed’s ‘nowcast’ for total CPI leans toward a 0.4% m/m rise with core at 0.3% (chart 5). 

Seasonal adjustments are likely to favour a reasonable strong rise in core CPI. As chart 6 shows, the four highest SA factors for core CPI during like months of December have all been in the pandemic era. This reflects the recency bias that creeps into calculations for seasonal adjustment factors that has them more heavily weighted to recent years in which the pandemic’s openings and closings and rebound distorted price signals compared to previous periods.

I’m expecting core services CPI ex-housing to remain elevated (chart 7). Goods inflation has been picking up (chart 8) and small business signals point to slightly more coming inflation pressure (chart 9). The weighted ISM price gauges also point to a pick-up in inflation (chart 10).

Since the producer price index for December lands the day before CPI I’ll use that combined with CPI to estimate the Fed’s preferred PCE measures. PPI components feed into PCE.

THE BANK OF CANADA’S BALANCE SHEET—WHY NOW?

The Bank of Canada will deliver a speech on “the balance sheet normalization process and how the Bank will manage its balance sheet once normalization ends” on Thursday. I have a feeling there will be more to it than that. The speech will be delivered in Toronto by Deputy Governor Toni Gravelle who is head of the Financial Markets Department and the Banking and Payments Department. He is brought out any time the BoC feels it necessary to update or alter its balance sheet management plans and has delivered several important speeches on the topic, like this one last March that I would encourage interested readers to review as a refresher.

But why now? I don’t have a great answer for that speaking first in terms of balance sheet developments. If it’s just to say everything is going tickety-boo, no reason to change, then why deliver a speech?

If it’s to signal a change in direction or a tweak to their plans, then why?

• There is no greater pressure on the Canadian Overnight Repo Rate Average relative to the policy overnight rate (chart 11). The spread is small at +3bps, and there has been a small positive spread for almost a year-and-a-half since the late summer of 2023. It’s neither widening or narrowing and it hasn’t caused much concern at the BoC before. The BoC has basically indicated it can live with a small deviation and it’s not changing.

• To date, the BoC has tended to dismiss concern that this spread may signal they are tightening liquidity too far and putting more upward pressure on market rates than the policy rate is trying to steer by instead saying that at times it has been a function of other things like liquidity and funding pressures in repo markets having to do with market speculation over future policy rate changes. They’ve said nothing to indicate greater concern.
• To date, the BoC has relied upon the use—or threatened use—of other tactics in order to steer the market measures of its policy rate more closely toward the administered policy rate, or to avoid allowing it to deviate further. Cash management bills, receiver general auctions, repo operations and forward guidance are included on this list, though the last one has been kind of sketch imo.
• The BoC is far away from its outlined goals for determining when to end quantitative tightening —the process of allowing the bonds it bought during the pandemic to mature and drop off the balance sheet at a 100% rate with no reinvestment. The BoC has said it wants settlement balances to fall back to a range of C$20 billion to $60 billion before ending QT. And yet they are nowhere close to this target with balances at almost double the upper end of this range and holding remarkably steady throughout the past year for various reasons not fully related to their QT program (chart 12).

• And Canada is heading into a period of potentially heightened uncertainty with possible tariff threats and retaliation around the corner. A steady hand is required, so maybe the speech will offer assurances that the BoC will do what it takes to preserve market functioning.

It’s also possible that the reference to balance sheet management as a topic isn’t the real focus. This is the last scheduled opportunity for a Governing Council member to speak before the communications blackout kicks in on the following Tuesday, January 21^st before the decision on January 29^th. A robust jobs report offers some assurances on the economy (recap here).

And so one other possibility could be to offer a sneak peek at the plans to offer more detailed modelling of a tariff threat in the January MPR. Governor Macklem indicated they would be doing so when he spoke in December. Any attempt at that is likely to be similar to our own (ie: multiple scenarios and ranges) since we don’t know exactly what will happen.

Embedded within that may also be a reminder of how the BoC may act in response to tariff wars in that its primary focus will be upon achieving 2% inflation over the medium-term come what may. Stronger easing may be likely if Canada faces tariffs but doesn’t retaliate; less easing or tightening may be likely if Canada does retaliate in a significant way. I would also expect assurances that the BoC will ensure proper market functioning throughout this period and do whatever is necessary.

Finally, it would be interesting to hear what Gravelle may say by way of how the BoC could manage the balance sheet if a surge of deficit financing in response to tariff wars results in much greater bond issuance. There is a high bar to bringing back QE in Canada and so this is more likely the sort of thing to park in the back of your minds for now. But to allow ongoing QT to dump bonds back on the market while issuance is surging—if this is a sustained scenario—could be a tough pill to swallow for bond market participants. The BoC would be less likely to weigh in on the topic if surging bond financing was due to profligate policies, but a crisis brought on by trade wars?

CENTRAL BANKS—ENJOY IT WHILE IT LASTS

Enjoy it while it lasts. By that I’m referencing the relative absence of major central banks weighing in with fresh communications and decisions. That will soon change when the Bank of Japan delivers a decision at the end of the week after next, followed by the Fed and the BoC that issue decisions on January 29^th following by the ECB the day after and the BoE the week after that. The Fed’s bias has turned relatively more hawkish (chart 13) and is likely to turn even further in this direction following a strong jobs report (recap here).

For now, there will only be decisions on offer by a pair of regional Asian central banks that while important to their markets, don’t hold much ability to sway global sentiment.

Bank Indonesia goes first (Wednesday) and is universally expected to hold its policy rate unchanged at 6%. Key is concern around the weakening rupiah that has depreciated by about 7% to the USD since the end of September. Concern toward financial stability risks and imported inflation won’t give confidence to ease while trade policy risks are overhanging the global outlook.

The Bank of Korea will deliver a policy decision on Thursday. It’s expected to cut by 25bps to 2.75% after cutting twice before, taking the policy rate down by a cumulative 75bps since October if they cut this week. Since the last meeting in late-November, both headline and core inflation have picked up from 1.3% to 1.9% and 1.7% to 1.8% respectively, although they are still below the 2% target. In addition, the won has been tumbling since October by a cumulative 12% depreciation to the dollar both on domestic political developments and external concerns related to a less dovish Federal Reserve and trade policy risks (chart 14). 

GLOBAL INDICATORS—SEVERAL GEMS ON OFFER

Several other global macro readings will primarily focus upon retail sales estimates from the US, UK and China to end the year, Chinese Q4 GDP, Australian jobs, UK CPI and a possible upward revision to Eurozone CPI.

China’s economy may have modestly accelerated to end 2024 (chart 15). Q4 GDP will be offered on Thursday evening (ET). Consensus estimates range from about 1.3 to 2% q/q at a seasonally adjusted but nonannualized rate. Equally important in terms of informing momentum into Q1 will be monthly indicators for December, especially retail sales and industrial output. Expect new and resale home prices to keep falling.

The main US indicator other than CPI will be Thursday’s retail sales for December. Headline is expected to rise by 0.6% m/m SA with sales ex-autos expected to gain by 0.4%. Vehicle sales were up by 1.8% m/m SA in December to their highest level since May 2021 and could two- or three-tenths to headline sales. It’s unclear that this is due to front loading of sales before tariff risks. Core sales will provide the first complete assessment of the holiday retail season but we’ll have to wait until January 31^st to get full consumer spending figures including more of the services side of the picture.

The US will also update the Empire (Wednesday) and Philadelphia (Thursday) Fed measures of manufacturing activity in January plus industrial production for December (Friday). Higher industrial output is expected to raise the capacity utilization rate back above 77% and arrest a multi-month downward trend.

Canada will update few relatively harmless indicators with usually low market risk. Manufacturing sales were previously guided to have risen by 0.5% m/m in November but may be revised (Wednesday). Preliminary estimates for wholesale sales suggested a drop of -0.7% m/m during November and may also be revised (Wednesday). A pair of housing reports will include existing home sales during December (Wednesday) that may end or at least interrupt a four-month long upswing, but earlier snowstorms than in past years and the holiday period always caution against interpreting too much into this. Housing starts are expected to pull back from the prior month’s gain (Thursday).

Is Australia’s jobs juggernaut still steaming full speed ahead? We’ll find out when December numbers arrive on Wednesday. Jobs have increased every month since April and almost 400,000 jobs were created over the first eleven months of 2024. Like Canada, Australia’s job market has been offering very strong supports to the economy. If unfilled job vacancies are any indication then Australia could keep on posting solid job growth (chart 16).

The last UK CPI report before the Bank of England’s decision on February 6^th will arrive on Wednesday. Key here will be whether the softer core CPI reading in November will extend into December (chart 17). If so, then it could reinforce market leanings toward a 25bps cut by the Bank of England on February 6^th. Also watch for holiday retail sales during December on Friday.

Watch for Eurozone CPI revisions. The main driver may be Germany that refreshes the initial CPI estimate of 0.4% m/m as it may be revised up a tick in light of the more recent data from individual states. Then Eurozone CPI could follow suit with a possible upward revision from 0.4% on Friday.

Other global indicators are summarized in chart 18.

Finally, a large number of top-tier US financials will report Q4 and full year results this week. Wednesday (Goldman, JP Morgan, Citi) and Thursday (BofA, Morgan Stanley) will be the two main days to watch. Analysts estimates are shown in chart 19.