Tim Graf (TG): This is Street Signals, a weekly conversation about markets and macro brought to you by State Street Global Markets. I'm your host, Tim Graf, European Head of Macro Strategy. Each week we bring you the latest insights and thought leadership from our award winning suite of research, as well as the current thinking from our strategists, our traders, our business leaders and a wide array of external experts in the markets. If you listen to us and like what you're hearing, please do subscribe. Leave us a good review, get in touch with us. It all helps us improve what we hope to bring to you. And with that, here's what's on our minds this week.

One of the most striking shifts in markets over the last two months has been the growing realization that the backdrop of the US economy, and particularly the mix of future US Fiscal and monetary policies were challenging the consensus view that US Equities, US Rates and the US Dollar were all poised to move even higher. At the same time shifting priorities in geopolitics, particularly America's desire to see a quick resolution to the Ukraine war and to also share more of the burden of European defense. This has proven a Damascene moment for European policymakers.

The German debt break seems to now exist in name only and European wide efforts towards common defense and infrastructure spending have put the Euro, European stocks and European rates all on the front foot, which is also kind of the opposite of what everyone was expecting at the start of the year. So it begs the question, given markets have now priced in a lot of these changes, is it time to move on to the next theme or maybe even play for a reversal? Or is there even more bad news to come for the US Economy and the dollar, particularly given a weak dollar would actually serve the Trump administration's interests quite well. Are there any further political efforts may be made towards weakening the greenback?

This week I caught up with our global head of Macro Strategy, Michael Metcalfe, to discuss all of these things. Well, first of all, I'm very impressed that your voice seems to be in decent shape today.

Michael Metcalfe (MM): Just about. I'm hoping it's going to last. There was a lot of singing yesterday, as you can imagine.

TG: Excellent, Excellent. For those not familiar, Michael's team, Newcastle United, (won) their first trophy since the 1969-1970 Fairs Cup. Is that correct?

MM: Oh my goodness, it is. You know, I can tell you last time I was at Wembley to support them was 25 years ago. And I've decided it's much more fun if they actually score a goal and then goodness if they win. Wow. It's really real privilege to be there and yeah, what a day.

TG: It's put you in a good mood today.

MM: It's put me in a really good mood. There isn't anything you can say that will possibly upset me.

TG: Well, let's talk about the US economy in that case.

MM: Yeah, there we go. Exactly.

TG: So yeah, we're going to make this mostly about the US this week, a little bit about Europe as well towards the end. But so far in the markets we are starting to think about and potentially price for a US Growth slowdown and there is talk about well I mentioned a growth slowdown but also stagflation or maybe even just above target inflation persisting for a little bit longer. I just wanted to get your overall take.

How would you characterize the state of the US economy in reality and which do you think of those outcomes is potentially most realistic for the remainder of this year?

MM: As you say, this has moved quite fast. Expectations around the US Exceptionalism theme as was reflected in positioning were just very solid going into the air. They were assumed to be sort of somewhat bulletproof and the data has thrown a bit of a spanner in the work. We know that some of the data is distorted. The January weather was an issue. There's a seasonal thing as well as in seasonal adjustments. But I think relative to expectations for 2 percent plus growth this year, where the consensus still is, I think of all those scenarios you highlighted, a slowdown is still the most likely. The reason why I'm not quite in the stagflation camp is I think if you do get that slowdown and it is driven by the consumer, then I don't think retailers have the pricing power to pass on any impact through tariffs, which is one of the things why people are concerned about above target inflation continuing.

TG: And let's talk about tariffs and the various scenarios and I should say we don't know really is the ultimate answer we are going to speculate here and there are a lot of permutations that could come to the fore, particularly ahead of and around. I think it's 2 April is the date where reciprocal tariffs are meant to be finalized and passed on.

What is your best estimate though for how inflationary ultimately tariffs might be?

MM: I'm going to, I'm going to have to hedge a little bit here just because obviously we don't know the size yet. Right. But here's a relatively straightforward way to think about it, I think. The Boston Fed did a nice paper on, you know, estimating the pass through from, you know, pretty significant tariffs on Mexico, Canada and China, which obviously are the, the US' three biggest trading partners. Those tariffs, if they were implemented in full and remained for the whole year, which obviously there's this huge uncertainty of if they do come in, how long, well, there's the uncertainty about when they come in and then if so, how long do they stay on for? The estimate of the impact on the pass through there into core CPI, core PCE, sorry, was about half a percent. Now if you translate what we currently see in new rental inflation, which obviously, you know, I bang on about a lot, that should mean for rental inflation that takes conveniently about half a percent off core PCE. So I think actually tariffs might be a bit of a wash relative to disinflation that we see from rents. So I don't think the tariffs will be too inflationary. I appreciate that's a bit of a hedged answer, so at least let me tell you what I'm sure about. What I'm sure about is that right now with data through the first half of March is we don't see retailers attempting to do any front loading of the tariffs in terms of pricing power. So we've seen a little bit in the import data there's been a surge in imports ahead of the potential tariffs. But what we haven't seen is any anticipatory pricing from retailers yet.

TG: What can you say about the state of demand? And because I think, well, you are alluding to our price stats, indicators of real time inflation that we capture through web scraping of retailers around the world, I wanted to ask about the demand side of that because typically I said this to a client a couple of weeks ago, before we had inflation like real inflation, I at least used to think about price stats as the consumer demand side of things and whether retailers had pricing power and whether the consumers had the ability to push prices higher through demand. We had retail sales data today, which as you mentioned, there are weather effects from the data the first couple of months of the year. January, the data was very weak because of weather. February, it looks like it was pretty strong.

What can you say, at least so far about the state of consumer demand? Whether it's using the lens of price stats or the actual data that we're getting released through things like retail sales and other consumption metrics.

MM: If you think about what price stats is, it's a daily pulse on whether retailers believe there's sufficient demand to warrant higher prices. Now obviously sometimes higher prices might come through from the fact that their costs have increased, but at the End of the day, retailers will be able to experiment in real time with adjusting online prices just to see whether demand will take the higher prices. We've got data through the first half of March. Now, this is typically a time of year when prices in the US do go up quite a bit. March seasonally is one of the stronger months for inflation. Price level has so far gone up in March, but it hasn't gone up as much as it normally goes up.

So consumers to some degree might be expecting higher prices, but resellers don't seem to be. Their view of demand obviously seems to be a little bit more sanguine.

The consumer confidence indicators in particular have been pointing to a much bleaker picture. But I think that the retail sales data in itself, consumption was very strong in Q4. It was always going to give something back in Q1, but I think it's giving back a lot more than we thought. You know, if consumption only adds a percent to GDP in Q1, that is a disappointment, despite all the other noise that's going on. So, on retail sales, the Chicago Fed has got a nice summary of some of the kind of the online data. They're very neatly advanced. Chicago Fed Advanced Retail Trade summary, which is called carts. That's actually been running a little softer than the official data, but again speaks to the same thing that the US consumer just is no longer quite as exceptional as it was.

TG: And it speaks to the broader softening that we started the conversation talking about. But it comes alongside inflation that in the official data is not quite back to target, at least not, you know, it's getting close to what the Fed is estimating for inflation by the end of this year. But that is not target inflation. But I wanted to talk about the Fed and this is not fair because this episode actually will go out just after the Wednesday Fed meeting. And so I will edit out anything egregiously incorrect that you're about to say.

MM: Oh, well, I'm fairly sure they're not.

TG: Going to move, they're not going to do anything. And to be fair, there is not much expected for them to even update those projections because they do look as though they were never heroic projections for this year anyway. And so it makes it quite difficult for them to be egregiously wrong. But the market is pricing basically what the Fed projections for rates are. I think there's about 60 basis points of further easing for the remainder of this year. Based on what we know so far. We are talking about slower growth. And with those consumer numbers you talked about that potentially sets us up for below trend growth.

So I'm wondering if that pricing, which is basically in line with projections is right or if you feel like it needs to deviate in any direction.

MM: I think the key phrase you said there, and this isn't actually waiting for the actual me saying, but it's based on what we know now. The challenge the Fed will have had to do the because obviously by now they'll have already done their forecasts is that they still don't know the exact shape of the tariff policy and they don't know that the tariffs, if they come might not get passed through. Going back to Alberta's study from 2018, the key variables that determine whether in the first round of tariffs what got passed through it was the size and the duration and actually the duration ahead of time is really hard to know. And as it currently sounds, we don't really know the size yet or at least we don't know the terminal size or however you want to call it. It's quite possible that if the US consumer slows Q1 is indicative of what's to follow.

And I think if the uncertainty created by the tariffs puts a bit of a break on investment spending, government spending is probably going to be curtailed as well. Then it's quite possible that their growth forecasts are a little bit lower. It's really interesting that our media stats data shows quite a sharp spike on media stories on layoffs. Now it turns out actually that media folks on hiring is also high but layoffs is much higher. That definitely seems to be having an impact on consumer confidence. But whether that translates into actual job losses, the indeed data doesn't show that yet, but obviously it might do may well be that the Fed is perhaps too optimistic on the unemployment rate as well. All of which would suggest in the future that rates might need to come down further than it's currently priced. Based on what we know now, they're probably about right.

TG: You bring up the notion of fiscal consolidation as part of that outlook. That might require lower growth forecasts. That does seem to be the focus with tariffs and government layoffs and the focus on getting budget deficits under control and potentially getting rates lower.

How realistic say is the 3 percent deficit target in your view, given it's 6 percent or so right now?

MM: I do wonder why people fixate with 3 percent deficit target. The European Union has had a very long run issue of those. I feel like it's some kind of long run historical average, but there's nothing particularly magical about 3 percent. But when people set a target that does become a bogey for them, obviously. And the interest cost alone could be at 3 percent of GDP just on that, let alone anything else. The thing that is also troubling about the US is that their cyclically adjusted budget deficit is much larger because the US Economy has been booming and they've still been running big deficits. If growth slows, automatic fiscal stabilizers kick in. All your cyclically sensitive parts of spending will need to go up and obviously your tax take goes down, that kind of thing. So the overriding theme is actually that growth is a bit slower than expected, even though that helps you with lower yields and reduces your interest rate costs. It then becomes really challenging, I think, to make the kinds of cuts to get to 3 percent of GDP.

TG: You mentioned Europe, so let's bring them into the discussion a little bit. I wanted to talk a little bit about the policies or the efforts that appear to be underway in Germany, but also in the EU more broadly in fiscal expansion. And again, something that we weren't necessarily pricing for at the beginning of the year was that Europe would become this fiscal hero almost in a way, bond markets have responded to this quite aggressively already.

First of all, how significant of a boost do you think could be coming for Europe? And second of all, how much of that do you think is now fully priced or close to priced by markets?

MM: This was a very positive surprise from Europe, and I think in Germany in particular, I think it was always there as a possibility that this is something that might occur. But I think there was just a doubt as to whether there would be the political will and to be frank, just the votes to get it through. It looks like it'll go through, but we're still not 100 percent sure we'll get release of the German handbrake on fiscal policy, if you like. I think in terms of have markets priced it in.

I would just point to our positioning data, which suggested that institutional investors biggest overweight in the sovereign bond space in February, unfortunately was actually in bunds. And so I think that there is a danger just in the short term that we get a bit of an overreaction to this news. And that continues to put upward pressure on German yields in particular as investors try and reassess that position in light of this fiscal news. And then I think on top of that, while we're seeing a rolling over of inflationary pressures from price stats in the US at the same time, actually, we're currently seeing actually quite sticky inflation in Europe. It pushes maybe investors away from thinking about European bonds being the safer place to be.

TG: Can you talk a little bit about the US side of this as well in terms of thinking about them as a spread? Because of this news, we've had inflation expectations in the US versus Europe narrow by about 25 or 30 basis points and do so very, very quickly. We've kind of derated the US and re rated Europe. That's also had a move in nominal yields where I think spreads have narrowed about 30 to 40 basis points in favor of Europe the last couple of weeks.

What does positioning look like on the other side of this in Treasuries and what have flows been doing there?

MM: Who's going to buy Treasuries is still one of the bigger questions for this year, I think. But in general, investors were better prepared for higher yields in the US than they were for high yields in Europe. So from a relative positioning point of view, we still have this big overweight in bonds and then underweight in Treasuries. But it's interesting, so far we haven't really seen the treasury flows recover yet. Purely just looking at positioning to answer the question whether the yield spread can move further in Europe's favor, the answer would be yes.

TG: That then naturally takes us to the currency, the dollar in aggregate. But Eurodollar specifically, what do positioning dynamics look like here? I mean, the dollar has really suffered the last few weeks and I think it's fair to say from our flows, we've seen quite a lot of dollar selling as part of that.

But what do position risks look like? Again, specifically to Eurodollar, but the dollar in aggregate as well.

MM: Institutional investors have been overweight the dollar for two and a half years now. But during that period we've had these intermittent and sometimes quite violent unwinds in that position where investors have decided they'll take the dollar holdings back to neutral. And interestingly, in each of those unwinds, investors opinions towards the Euro have always lagged. And that's been true in this case as well. So in other words, when investors have lost faith in the dollar or lost confidence in dollar appreciation, I should say the Euro hasn't been their first go to. That was also true in this 2025 version of it. But what that means when we look at the data today is that dollar holdings have almost fully corrected back to neutral. The euro again has lagged. And so euro holdings to us still look, you're really quite underweight. And so there's still, you know, even though in price terms, euro, dollar, it looks like it can't go any further. If institutional investors continue to unravel their euro short, that's going to put upward pressure on the euro for sure.

TG: Can you give a sense of where further dollar selling might come from? In other words, who might still be overweight dollars even if the aggregate is a little bit closer to neutral? Are there particular investor classes and hedgers that you would look at to see whether that behavior changes to create further dollar selling and therefore further dollar weakness?

MM: Yeah, there are. And the reality is what we've seen so far in the dollar unwind has been quite uneven in the sense that US domestic investors have been very quick to square up their dollar position. US fixed income managers are now back to kind of neutral, we would say, or at least relative to long term averages. The investors that haven't been as fast to adjust are basically foreign investors in general. They've lowered their head ratios on US assets. They do have the potential to lift them as dollar weakness continues. And I think in particular we're going to focus there on the behavior of or how investors, how foreign investors in US equities think about their dollar exposures.

TG: That's a really interesting one because this is a client question I got last week that I thought was very good. And it was with regards to the dollar's correlation to equity markets, US equity markets. It does seem as though the dollar is selling off with equities as opposed to rallying with equity markets selling off.

Do you think this is because of that hedging related activity and do you think that will continue that trend we’re seeing towards both the dollar and US equities going down?

MM: Yeah, I think so. I think the two could quite easily be related. And many of us are familiar with the concept of the dollar smile and this idea that when the economy is booming, the US does well because it gets higher interest rates and attracts capital. But the left hand side of the dollar smile is that when things are going wrong and investors are defensive, the dollar also wins as a kind of a safe haven in that environment. And I think what's happened so far this year is that the bit that's gone wrong is actually the US exceptionalism story. And part of that story was that foreigners had dramatically increased their holdings of US equities and at the same time had quite a low hedge ratio on those holdings. And so what's happened when we've had this kind of rebalancing in equities away from the US and certain sectors in the US back into Europe in particular, when equities have gone down the dollar has also gone down with it because of those relative flows. And so there's an interesting question here as to whether the dollar's safe haven status, given this kind of particular shock, has been weakened somewhat.

TG: There's other factors I wanted to think about with regards to a weaker dollar and to kind of finish on the policy side of things. I'm a junkie for market history and especially being a currency person, thinking about things like the Plaza Accord as being seminal market moments that I think are really informative in thinking about markets today. And of course we have this discussion not of the Plaza Accord, but the Mar-a-Lago Accord. And I wanted to first see if you can talk us through what that is, but also how seriously you take it as a means of weakening the currency.

MM: As far as I'm aware, they didn't hire out Yankee Stadium as was once promised by one of the US treasury secretaries if the strong dollar policy had changed. But I think this is very clearly a desire not to have an ever strengthening dollar. And they're kind of proposing various mechanisms by which that could be achieved. Now one of the things that the Mar-a-Lago kind of accord or that the press around it talks about is this idea of trying to encourage foreign central banks to somehow reduce their accumulation of reserves. I actually think that's been much less of a driver for the dollar in recent times anyway.

Reserves don't appear to have been a large part of the dollar's appreciation. I think it's been much more driven by the private sector and outperformance of US assets, which is why when those have reversed, dollar strength is reversed. The other thing that kind of runs alongside that, talking about the question I asked before about who's going to buy Treasuries. The reality is that the US is still asking a lot of foreign investors to buy significant amounts of US treasuries. And so on the one hand they're trying to argue that foreign central banks didn't accumulate, but then there's also an ask for them to buy long dated debt in return for security protection. So I think that part of it you can see the logic behind it, and I think there are certain countries where you can see it might make some sense. The policies of the Japanese authorities and their role in trying to prevent the yen from the yen is strengthened a lot, but it's still very undervalued by most metrics, including our own PPP metrics. It's hard to see outside of Japan, authorities outside of the US buying into this in a Big way and allowing their currencies to appreciate a lot because it's only really in terms of valuation misalignments. Right now it's really just the yen that stands out. So I think it might have some implications for the yen. I'm not quite sure whether it has implications on a broader basis.

TG: There are two final kind of extreme cases I wanted to talk about with respect to what the administration and the Treasury Department might do with respect to the dollar. And the first is something I know you've looked at in the past. I think it was during the first Trump administration, in fact, was the notion of capital controls or capital charges. And Gillian Tet wrote an article in the FT about this last week. And I mean, clearly this runs contrary to some of the tenets of a Mar-a-Lago Accord where you're trying to encourage inflows, particularly into longer dated treasury securities.

Is this something that could actually be realistic in your view? And ultimately, how damaging might that be to the dollar if it does see.

MM: The light of day in the first version of the trade war? One of the points that we talked a lot about then was okay, this is going to damage global trade, but actually as long as it stays out of the capital account, then its impact on portfolio construction and investors desire to move money abroad. Actually, if anything, because it meant that you had divergent economic performance, it actually encouraged international investment. And so it wasn't as much of a headwind for markets if you get this kind of drift. Cross border capital flows are multiples of trade flows. Even if you just get small measures to potentially disrupt them. You're talking about quite significant sums of money, how that might impact foreign exchange rates. For example, you very quickly might get a focus in a much stronger focus on countries with large current account deficits because of course they rely on free flowing cross border portfolio flows in general to fund those current account deficits. If you got escalation in some kind of capital account, sort of tit for tat could feasibly be quite difficult, not just for the dollar, but for any country or currency that runs a significant current account deficit. But I think that's extending what is just right now, just a very small step towards it. And so that would be a tail risk.

TG: Yeah, it does seem quite hyperbolic. But there's one last risk I wanted to ask about, and this is kind of a pet theory of mine, what the announcement of abandoning the strong dollar policy of the US might look like in terms of they'll let everybody know. But that's the question I then have is there a chance that this strong dollar policy that was put in place during the Clinton administration under Robert Rubin and has really been adhered to ever since.

Not that they would necessarily go for a weak dollar policy, but is there any way in your mind they can start to soften that language and move to a much more balanced way of talking about the dollar and that being effective as a signaling tool?

MM: I think that is exactly what they're doing and that just the phraseology around strong dollar policy, for a while the market became quite obsessed with it and every treasury secretary had to say it. And then you got kind of nuances of it, which meant that strong dollar doesn't mean an ever strengthening dollar and that kind of thing, which, you know, all of which makes sense. I mean the dollar should be stable, but that doesn't mean it Put it this way, strong dollar policy wouldn't justify some of the levels that we've seen in dollar yen in the last three or four years. The dollar has been ridiculously overvalued against the yen. The kind of noises that we're seeing about the dollar are definitely a rebalancing of that, but there is a limit given the need for foreigners to buy Treasuries still as to how far you can push that. The US ultimately is still a large current account deficit country and will rely on foreigners to buy its assets. And so you don't need to have an ever strengthening dollar policy, but I think it's very difficult to have an explicitly weak one.

TG: Fantastic. I have no good way to close this.

MM: Can we just go back to Newcastle again?

TG: That would be. Yeah, I need to. I was trying to think of some football analogy as you were giving that very coherent answer and I don't really have one. Actually I do. This week I'm experimenting with something new. Every episode of Street Signals, I do a ton of prep work. I draft show notes and come up with questions. And during most podcasts there are indicators and data points that we talk about that might be interesting for you to see. But you as an audience are basically flying blind.

So this week, and hopefully in many future weeks, depending on how lazy I am. If you are a subscriber to our research via our Insights platform, around the time this podcast goes out, I'll also publish a one pager of charts and notes for my conversation with Michael that will hopefully give a visual context to some of the things that he and I have mentioned. For now, it's only available on Insights, so you'll have to be a client who gets our research. To get that, if you're a prospect, reach out to me on LinkedIn or Twitter. I'm Tim Graf there and we'll see what we can do. So there you go, that's our ending. Michael, thanks as always.

MM: Pleasure, Tim.

TG: Alright-y, thanks for listening to this week's edition of Street Signals from the research team at State Street Global Markets. This podcast and all of our research can be found at our web portal Insights. There you'll be able to find all of our latest thinking on macroeconomics and markets where we leverage our deep experience in research on investor behavior, inflation, risk and media sentiment. All of which goes into building an award winning strategy product. If you're a client of State Street, hit us up there at globalmarkets.statestreet.com and again, if you like what you've heard, subscribe and leave a review. We'll see you next time.