US Inflation Cools Sharply, Raising Stakes for Fed Rate Decisions
US inflation moderated significantly in February, sliding to 0.2% from January's robust 0.5%, undershooting market expectations of 0.3%. Core inflation also eased to 0.2%, falling short of forecasts at 0.3%. Year-on-year headline inflation dipped from 3.0% to 2.8%, while core inflation slowed to 3.1%, down from 3.3%, compared to expectations of 2.9% and 3.2%, respectively.
Declines were pronounced in several categories: energy costs contracted by 0.2% year-on-year, shelter inflation softened to 4.2% from 4.4%, and inflation for used cars and trucks eased to 0.8% from 1%. Transportation costs notably decelerated to 6% from 8%, and new vehicle prices continued their descent at -0.3%. Conversely, food prices slightly accelerated to 2.6%.
Markets responded optimistically to the inflation data, anticipating heightened pressure on the Federal Reserve to implement at least multiple rate cuts this year, driven partly by ongoing tariff uncertainties. Yet, despite aligning directionally with rate-cutting expectations, inflation still remains notably above the Fed’s 2.0% target. Additionally, aside from early signs of weakness in housing, broader growth indicators across the US economy remain relatively resilient.
We maintain our stance that the Fed may remain cautious about cutting rates, especially given potential inflationary pressures stemming from tariffs and tight labor policies. However, a further deterioration in key growth metrics would prompt us to reconsider and possibly revise our outlook.
Tracking Trump policies
Increased tariffs on all U.S. steel and aluminium imports took effect on Wednesday, as Trump stepped up his campaign to reorder global trade in favour of the United States. However just hours after announcing higher tariffs on Tuesday, Trump backed down from his pledge to increase tariffs on Canadian steel and aluminum to 50%, reducing them instead to 25%. This reversal followed a Canadian official's decision to abandon plans for an additional 25% surcharge on electricity supplied to several U.S. states.
Despite the retreat from Trump Canada and EU swiftly retaliated and. Canada as the largest supplier of steel and aluminum to the US, announced that it will place 25% reciprocal tariffs on steel products and also raise taxes on tools, computers and servers, display monitors, sports equipment, and cast-iron products. Uncertainty and unpredictable US policy in the meantime as urged the Bank of Canada (BoC) to lower policy rate by 25bps to 2.75%. The statement noted: "Increasing trade tensions and U.S. tariffs will slow down economic activity in Canada and heighten inflationary pressures." It is highlighted that recent surveys pointed to a sharp decline in consumer confidence, preventing decision making and a slowdown in business spending as companies postpone or cancel investments.
In a decisive response, the European Commission unveiled a robust series of countermeasures targeting the United States' newly imposed tariffs on steel and aluminum imports from the European Union. Simultaneously, the Commission is preparing to reinstate the previously suspended "rebalancing measures" originally introduced in retaliation against former US President Donald Trump's aggressive tariff policies from 2018. The combined package of measures is expected to impact approximately €18 billion ($19.6 billion) worth of American goods. These carefully calibrated measures aim to precisely match the scale of economic damage inflicted upon EU trade by the recent US tariffs, underscoring the EU’s resolve to maintain balanced trade relations and protect its economic interests.
Bund Yields Soar to 17-Month Peak Amid Massive Infrastructure and Military Boost
Driven by Germany’s unprecedented €500 billion infrastructure stimulus and Europe's renewed commitment to increased military expenditures, Bund yields are experiencing a dramatic surge, reflecting heightened optimism for economic expansion. The 10-year Bund yields soared yesterday to a fresh 17-month peak, hitting an impressive 2.931%. This upward momentum marks an extraordinary leap of nearly 45 basis points in just one week—the steepest weekly rise recorded since 1990. Market sentiment has shifted notably, with traders now pricing in a 50% likelihood of a 25-basis-point rate cut by the European Central Bank (ECB) during its April 16-17 meeting, signaling easing fears around growth threats posed earlier by U.S. tariffs.
Euro Retreats as Germany's Fiscal Stimulus Hits Political Roadblock
The Euro, having recently surged above the critical 1.09 mark, retraced part of its gains amid renewed strength in the US Dollar Index (DXY) following softer-than-expected US inflation data, and growing uncertainties over Germany’s ambitious fiscal stimulus plans. This reversal intensified after Germany's Green Party firmly rejected Chancellor-in-waiting Friedrich Merz's €500 billion infrastructure fund proposal, alongside his planned reforms aimed at easing constitutional debt limits to bolster defense spending.
The Greens criticized Merz's plan as insufficiently geared toward climate protection and forward-looking, sustainable investments. Instead, the party proposed exempting defense and security expenditures exceeding 1.5% of GDP from constitutional debt restrictions. This political standoff represents a substantial obstacle for Merz’s economic agenda, as constitutional amendments require a two-thirds majority in the Bundestag, making Green Party support indispensable.
The deepening political divide may trigger a complete shift in market sentiment, potentially reversing the recent optimism driven by expectations of European fiscal expansion. Escalation of disagreements could prompt investors to seek refuge in safer assets, placing downward pressure on Bund yields and contributing to a softer Euro, as growth prospects diminish and markets anticipate possible monetary easing by the European Central Bank. On the flip side, renewable energy and climate-related sectors might experience positive momentum if the Greens' alternative proposals emphasizing sustainability gain traction.
LOCAL MARKETS
Local markets in Turkiye continued to positively deviate from global volatility with BIST ending the day 1.36% higher at 10,580. USDTRY was almost flat at 36,58 while EURTRY eased below 40.0 mainly due to global retreat in Euro to below 1.09. Bond yields have somewhat eased and 2Y benchmark bond yield came down to 37.0% on a 0.11pps daily decline.
Breaking the Cycle: No Sustained Drop in Turkey’s Current Account Deficit
In January, Turkey’s current account deficit surged dramatically to USD 3.8 billion, sharply deteriorating from a deficit of USD 2.3 billion recorded in the same month the previous year. Consequently, the cumulative 12-month deficit expanded from USD 10 billion to USD 11.5 billion. Robust domestic demand and a real appreciation of the Turkish lira have accelerated import growth while simultaneously curbing domestic production. With limited expectations for significant contributions from exports in the near future, the current account imbalance is likely to persist or even worsen. Indeed, preliminary data from the Ministry of Trade indicates continued deterioration, with a USD 1.35 billion decline in the trade balance in January followed by a further USD 1.39 billion downturn in February.
Debt-financed capital inflows surged significantly in January, reversing the prior year’s trend from an outflow of USD 4.4 billion to an inflow of USD 11.8 billion. This notable increase predominantly stemmed from loan utilization totaling USD 10.5 billion and a portfolio investment influx of USD 2.2 billion. Consequently, the annual rolling capital inflow expanded substantially, rising from USD 23.3 billion to USD 39.5 billion. This comprised USD 4.5 billion in foreign direct investment (FDI), USD 13.7 billion in portfolio investments, and USD 21.2 billion from other investment channels. Within these other investments, bank loans accounted for USD 33.8 billion, whereas Central Bank deposits decreased significantly by USD 37 billion over the past year. Debt instruments remained the dominant force within portfolio investments, totaling USD 25.6 billion, of which government domestic debt securities (GDDS) comprised USD 17.4 billion, and bank and corporate Eurobonds totaled USD 7.5 billion. The substantial USD 39.5 billion capital inflow against an USD 11.5 billion current account deficit facilitated a reserve accumulation of USD 13.2 billion. Nevertheless, the reserve build-up was curtailed by a substantial USD 14.6 billion net error and omissions capital outflow.