USD to strengthen further following the start of tariffs escalation

A more cautious Fed when it comes to rate cuts in 2025, tariff and China uncertainties will likely keep USD/VND anchored to the upside. Overall, UOB's updated USD/VND forecasts are 25,600 in Q1/2025, 25,800 in Q2/2025, 26,000 in Q3/2025 and 25,800 in Q4/2025, write the Singporean bank's analysts.

The new normal of constant tariff threats

The brief calm in late January following President Trump’s inauguration was finally shattered in early February by renewed threats of punitive tariffs against Canada, Mexico and China.

While at the moment of writing, both Canada and Mexico appear to have won a precious one month reprieve, the 10% tariffs against China appear to be going ahead with China announcing retaliatory measures.

President Trump’s brinksmanship tariff threats coupled with last minute negotiations against US trade partners may well be the new normal. Financial markets may be complacent in not acknowledging in full the macroeconomic effects of the tariff threats and pricing in an adequate “Tariff Risk Premium”.

Amidst the renewed rise in US inflation expectations, the US Dollar is the key beneficiary of this “Tariff Risk Premium”. We see the USD Index (DXY) rising further to 112.6 by 2Q25.

Our expectation of one 25-bps Fed rate cut this year now contrasts starkly with the anticipated 75 bps from European Central Bank (ECB), 100 bps from Bank of England (BOE) and Reserve Bank of Australia (RBA) and 125 bps from Reserve Bank of New Zealand (RBNZ) for the rest of 2025.

This widening rate differential will be a key tailwind for the USD against its Major FX peers, anchoring further USD strength in the first half of 2025. The EUR will of course face additional pressure from the on-going tariff threat from the US. We forecast EUR/USD leading the drop to 0.98 by Q2/2025, followed by GBP/USD dropping to 1.20 and AUD/USD softer at 0.59 by 2Q25.

As for the CNY, in-between China’s growth slowdown and further escalation of tariffs to our Base Case expectation of 25%, further depreciation is a given. We maintain our forecast for USD/CNY to rise further to 7.65 by Q3/2025. Other USD/Asia FX will follow suit with highs for USD/SGD, USD/MYR, USD/IDR, USD/THB and USD/VND to be registered in Q3/2025 at 1.40, 4.65, 16,900, 35.40 and 26,000 respectively.

Finally, we note that interesting developments on the bullion front, whereby the futures and LBMA price premiums against spot price has widened alongside the jump in physical gold delivery into COMEX. This confirms various industry news of outsized physical gold shipment from London and Europe into New York amidst the escalating trade tensions. This affirms the rising safe haven risk premium for gold and reinforces our positive outlook for $3,000/oz by end-2025.

It has been a wild rollercoaster ride for financial markets since the start of February. U.S. President Trump initially threatened to implement a punitive 25% trade tariffs on both Canada and Mexico on an immediate basis (with energy imports from Canada tariffed at a “preferential rate” of 10%), only to agree to delay them for a month pending further negotiations with both countries.

Both sets of tariffs against Canada and Mexico if implemented to the fullest will have significant adverse impact on both economies. Consensus estimates suggest that both Canada and Mexico’s economies will very likely slip into a recession as a result.

As for China, at the moment of writing, the world’s second biggest economy appears to have responded with retaliatory tariffs against coal, liquified natural gas, crude oil and other goods originating from the U.S. In addition, China has also announced export curbs against various rare metals. This was after the U.S. signaled that it will proceed with the blanket 10% tariff against Chinese goods into the U.S.

It is important to note that both Canada and Mexico accounted for a substantial 41% of total U.S. imports. In the energy space, both Canada and Mexico supplied as much as 75% of crude oil imported by the U.S. As a rough rule of thumb, the consensus estimate suggests that against the baseline, the US economy will take a 1% GDP hit together with a 0.5% rise in inflation.

While both Canada and Mexico may have won a temporary month-long reprieve, in our scenario analysis, our Base Case (with 55% probability) assumes that tariffs may eventually be imposed across the year till H1/2026, on imports from both countries at 25% (although we also note the non-negligible probability that tariffs may be rolled back or not be imposed if both countries accede to the demands of President Trump), including 25% tariffs on China as well.

Given these assumptions, we reiterate our Base Case scenario for U.S. GDP growth to slow to 1.8% this year and CPI inflation to rise by 0.4% point to 2.5% and China’s GDP growth to slow to 4.3%.

However, the risks to the global economy and financial markets do not stop there. There is an increasing and constant risk that U.S. President Trump may well impose tariffs against the European Union or raise tariff threats anew against key trading partners like Canada, Mexico and China. On a worst case basis, he may impose a substantial universal blanket tariff on all imports into the U.S.

This is captured in our Pessimistic Case (with 40% probability) assumption that tariffs may increase further against Mexico and Canada with China landing at a materially higher 60% and rest of world enduring a potential blanket universal tariff of about 10% to 20%. In such a scenario, U.S. GDP growth is estimated to slow to just 1%, with inflation jumping a full 1% point from baseline to 3.1%. China’s GDP growth will likely slow further to just 3.5% this year.

Going forward, financial markets and global investors will likely need to live with the constant threat of tariffs and last-minute brinksmanship negotiations in the months ahead. Such uncertainty and intra-day whipsaw are likely to be the new normal and it begs the question whether financial markets have priced in the on-going tariff threats in the form of a “Tariff Risk Premium”.

The immediate consequence of this increasing “Tariff Risk Premium” is the renewed rise in inflation expectations for the U.S. As a result, Fed Fund Futures have started to fade expectations of further rate cuts going forward, with various Federal Reserve officials now reiterating the prudent “wait and see” stance for now.

Needless to say, the U.S. follar is the key beneficiary of this “Tariff Risk Premium” and the accompanying renewed rise in US inflation expectations. In particular, two-year U.S. inflation expectation has doubled from 1.5% last November to current level of about 3.0%. Overall, the USD Index has now risen about 9% from its low of 100 before the U.S. President election last November to current level of about 109.

Our Base Case assumes that by Q3/2025, DXY will rise further towards 112.6 by Q2/2025 accompanied by EUR/USD falling below parity and USD/CNY rising to 7.65 by Q3/2025. In our Pessimistic Case scenario, the risk is that DXY will jump to 115 and USD/CNY may well rally towards 8.0. It would not be prudent to fight this trend of USD strength, at least until later this year when we can have a better gauge of the breath and scope of the tariffs and the corresponding impact on the U.S. economy.

USD to strengthen further following the start of tariffs escalation

The USD pulled back for the first time in four months in January as President Trump stopped short of swift tariff action after he was sworn in on January 20. As markets previously bought up the USD in anticipation of day-one tariff action against key trade partners such as Canda, Mexico and China, the reprieve spurred some profit taking in the US Dollar Index (DXY) which had risen to two-year highs in early January.

The brief calm in financial markets was shattered when President Trump signed off the first tariffs in his new term against Mexico, Canada and China on February 1, before agreeing to delay tariffs on Mexico and Canada by one month. However, at the moment of writing, it appears that additional tariffs against China are going ahead with China responding in kind as well. How do we navigate through this fluid tariff war? And will the USD strengthen further after stabilising in Jan?

Most Asia FX had a positive start to 2025 as the much-feared day-one Trump tariffs against China did not materialize. Even as President Trump eventually announced 10% tariffs on China goods on February 1, China’s toned-down response relative to Canada and Mexico means that the frontlines of the new trade war may be with U.S.’s immediate neighbours, a key departure from the 2018 US-China trade war. Will this translate to lesser spillover to the CNY and other Asia FX? Or is there room for further tariff escalation with China?

Brace for further Asia FX losses as we expect further ramp up in Trump’s tariffs against China

While President Trump had imposed a modest 10% tariff on Chinese imports, we think the risk of future tariff action remains high. The Office of the US Trade Representative (USTR) has announced on January 24 a review of the “Economic and Trade Agreement” between U.S. and China to determine whether China is acting in accordance with the commitments it made in the agreement. This may be the precursor of any tariff recommendation made to the president.

Furthermore, U.S. Treasury Secretary Scott Bessent is reported to push for new universal tariffs on US imports to start at 2.5% and rise gradually while Commerce Secretary nominee Howard Lutnick is said to be a strong advocate for higher tariffs. There is also increasing concern that the U.S. may well ultimately revoke China’s “most favored nation” trade status.

That said, China’s responses so far has been measured and that President Trump is staging a multi-pronged extended tariff fight probably means that the immediate spillover to the CNY and rest of Asia FX may be more measured.

Although we expect further tariffs on China upon completion of the USTR investigation, our pessimistic case of 60% tariffs is unlikely to materialize yet. For now, we are also keeping to the 4.3% 2025 China GDP outlook, assuming our base case of a further increase of tariffs on China imports to 25% from 10%.

A significant China stimulus package this year may also help to cushion economic growth and lessen the extent of the CNY adjustment required. For now, we are keeping to our existing USD/CNY forecasts which are at 7.40 in Q1/2025, 7.55 in Q2/2025, 7.65 in Q3/2025 and 7.50 in Q4/2025 which were premised on our existing base case of 25% tariff on Chinese imports to the U.S.

However, in the event of 60% tariff, it would be difficult for People’s Bank of China (PBOC) to reign back more extended CNY weakness and we reiterate our view that USD/CNY may rise above the psychological 8.0 level, last seen in 2006.

There was some reprieve for the VND in January as President Trump did not impose the much-feared day-one Trump tariffs against China. Consequently, USD/VND pulled back from its record high near 25,500 to about 25,100 across Jan. The brief calm was punctured after Trump announced tariffs against Mexico, Canada and China in early February, sending USD/VND back higher towards 25,300.

A more cautious Fed when it comes to rate cuts in 2025, tariff and China uncertainties will likely keep USD/VND anchored to the upside. Overall, our updated USD/VND forecasts are 25,600 in Q1/2025, 25,800 in Q2/2025, 26,000 in Q3/2025 and 25,800 in Q4/2025.

Commodity Strategy

Rising safe haven demand for physical gold bolsters positive outlook for $3,000/oz

Something interesting is happening in the bullion market. Since the start of the year, there has been an outsized spike in gold futures delivery into COMEX, coupled with a strong jump in physical gold inventory on COMEX. There are also tell-tale signs of widening in price premium for both front month gold futures and LBMA price against spot price.

Various industry reports also suggest that there is increased delivery of physical gold from London, Europe and various parts of Asia into New York. Putting all these together, these latest developments suggest there is elevated demand for physical gold in the U.S. amidst escalating trade conflicts between U.S. and its major trading partners.

This latest development reinforces our existing view of rising safe haven demand for gold, not just from central banks for increased reserve allocation, but also from retail investors across the world as well for gold jewellry. More importantly, this rising safe haven demand for gold is also helping gold deflect away the negative pressure from the stronger USD.

As such, extending from last year’s strong rally, gold has risen further year-to-date, from $2,650/oz in early January to a new record high of $2,820/oz. The latest signs of elevated safe haven demand for gold reinforces our positive outlook for gold and we reiterate our $3,000/oz forecast by end-2025.