February 7, 2025

Welcome to Aurora Macro Fridays, your weekly overview of what matters most in global macro. Today's theme is an inflation problem.

0. Talk of the Town 

• As regular readers know, in last week's AMF, I tried to find a benchmark to define what success would look like for the Trump administration. I came up with the 10Y rate.
• Now either Scott Bessent is a regular reader (hi Scott!) or the administration shares my thinking on which benchmarks it should be focused on. I would take either read as good news. 
• External link: In an interview with Larry Kudlow full of political soundbites and Laffer curve fantasies (skip to about 9:50 if you don't want to listen to those), Bessent mentioned that "[Trump] and I are focused on the 10-year Treasury and what is the yield on that" rather than what the Fed does. 
• The market liked that a fair bit, because it's the right thing to focus on if you're worried about Fed independence, and fiscal expansion, and inflation expectations--all these things find their way into the 10Y.

1. We Probably Have an Inflation Problem

• Given all the trade talk and policy talk and deficit talk, it's understandable that the Fed wants to stay pat and see how things play out. We didn't know much about tariffs at the last Fed meeting and it's not clear that we'll know much more by the next one. 
• The academic debate has focused on whether tariffs are a transitory or permanent shock. The standard argument goes that tariffs are a one-off, so they're not really inflationary, they just change the price level. Christopher Waller and others auditioning to replace Jay Powell have made this point repeatedly.
• I guess that's a fair academic question, but can you really see Powell telling us not to worry about this coming inflation wave because it's "transitory?" 
• I personally struggle to see that, especially given today's more interesting data print: about a half hour after the jobs report (which we wrote about this morning, link here), preliminary Michigan figures came out and they look messy.
• 1-year inflation expectations jumped from 3.3% to 4.3%--the highest month-on-month change since May 2021 and the third month-on-month increase in a row.
• For reference, we never got three consecutive month-on-month increases during the 2021-23 inflation wave. 
• Amazingly, the increase was despite the fact that the median Republican expects 0% inflation [sic] over the next year--down from 3.6% in October. Democrat (5.1%) and Independent (3.7%) expectations just moved very quickly in the opposite direction.
• The longer-term, 5-10-year inflation expectations also came in high --at 3.3%, they are at their highest level since June 2008. It is worth noting that this is not a very volatile sample--before June 2008, the last time 5-10Y inflation expectations were this high was 1994.
• Here, too, the party breakdown is shocking--the median Democrat saw their 5-10Y inflation expectations jump from 2.7% in September to 4.2% today--the median Republican went from 3.4% to 1.5%.
• Now I should of course note that these numbers are preliminary and subject to revision and we had a similar 3.3% scare in the summer of 2022, when the Fed hiked by 75bps. 
• But it's still a scary number, especially since it comes before the administration's inflationary trade policy, or its inflationary immigration policy, or its inflationary fiscal policy have had a chance to take effect. 
• Next key date is Monday when the NY Fed's survey of consumer expectations comes out. 

2. Canadians are Done Being Nice

• U.S. trade policy has become so high frequency it has become more of a technical than a fundamental trade. 
• Last Friday morning, 25% tariffs on Canada and Mexico were meant to go into effect. Around mid-day, when this newsletter went out, a Reuters report pushed out the date to March 1. A few hours later, the administration denied the report, saying the tariffs were coming Feb 4. On Saturday, the tariffs were announced, by Tuesday, they had disappeared again.
• As I'm writing this, Trump is welcoming the Japanese Prime Minister to Washington by threatening tariffs on Japan: *TRUMP SAYS TARIFFS ON JAPAN ARE AN OPTION
• Will there ever be tariffs on Canadian and Mexican goods? It's anyone's guess, but here's a few things I've found out about the political economy of it all.
• The Canadians are really, really mad. I get it. They are probably the best neighbor any country could ever have wished for. Excluding energy, the 
  U.S. has a bilateral trade surplus. And yet, out of the blue, Trump essentially threatened them with a three-year recession. 
• Since then, two things have happened north of the border: first, the public is really mad and boycotting American products and booing the national anthem and engaging in other activities of no macroeconomic significance.
• Second, the Liberals have seen a resurgence in the polls, and the Conservative victory we all assumed was a shoo-in this year looks less likely (still likely, but less so). 
• It would surely be rich irony if Donald Trump helps install either Chrystia Freeland (Harvard BA, Oxford MSt) or Mark Carney (Harvard BA, Oxford DPhil) as the next Canadian minister. There is hope for the globalist elites after all. 
• The other thing I learned is that Canadian policymakers really view the delay in tariffs as a delay--not a "see you never." 
• This is in contrast to financial markets, which have settled on the tariffs being a bit like British invitation to dinner--something you say, not something you do.
• Internal link: The reality is no one really knows where we'll land. No one? Well maybe not no one--our trade expert Dmitry Grozoubinski recently wrote Ten Lessons on Trump's Trade Policy. If you missed it, you can pick up your copy here. 
• If I had to bet, the U.S. - Canadian economic relations framework will look roughly the same 12 months from now.
• But the trust has already been broken, and Canadian businesses will be looking to diversify away from U.S. consumers regardless of the outcome. 
• Incidentally, the CAD remains the most shorted currency among leveraged positions in the CFTC's tracker--which makes it fertile trading ground regardless of the short-term tariff outcomes. 

• Next week in the U.S: starts with the NY SCE at 11AM EST on Monday; we then get CPI at 8:30AM on Wednesday, PPI on Thursday, and January retail sales on Friday. 
• Fed Speakers include Powell's testimony before the Senate Banking Committee (Wednesday) and the House Financial Services Committee (Thursday), as well as Williams, Bostic, and Hammack. The Senate session usually has better Q&A.
• Next week in Europe we get industrial production on Thursday and a second GDP read and 4Q employment figures on Friday. 
• ECB Speakers include Lagarde testifying before the European Parliament on Monday, and Schnabel, Nagel, and Cipollone.

Have a great weekend,

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