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Weekly Economic Roundup: DeepSeek Impact, Tariffs, and Central Banks

Markets face volatility amid DeepSeek's challenge to U.S. AI dominance and Trump's impending tariff actions. As the Fed holds rates steady at 4.25%-4.5%, global central banks pivot to rate cuts. Gold approaches $2,800 on safe-haven demand, while traders await crucial U.S. inflation data. Trump's planned 25% tariffs on Canada and Mexico, set for February 1, heighten trade war concerns.


Tech Sell-Off, Trade War Fears, and Fed Policy: A Volatile Week for Markets


At the start of the week, shaken by the DeepSeek phenomenon, traders have been closely monitoring the Federal Reserve's decision and U.S. growth data. Now, all eyes are on the critical inflation data set to be released later in the day. Meanwhile, President Donald Trump's ongoing tariff threats against Canada, Mexico, and China remain in focus.


DeepSeek, a free AI assistant developed by a Chinese startup, recently launched a new version. On Monday, reports emerged that it had surpassed its U.S. competitor, ChatGPT, in App Store downloads, fueling doubts about the U.S.'s standing in the AI race. This development sent shockwaves through the markets.


Unlike traditional AI models that require high-end chips and vast amounts of data, DeepSeek operates on lower-cost chips and is claimed to mimic human reasoning. Its rapid adoption has raised concerns that it could pose a potential threat to OpenAI and other U.S. competitors dominating the market. Some analysts predict this could lead to a trillion-dollar loss in market value for these companies.


These fears triggered turbulence in global markets at the beginning of the week, dealing a heavy blow to U.S. tech companies. Chipmaker Nvidia saw its market value shrink by $593 billion, marking a record one-day loss for any company on Wall Street. The S&P 500 index, where the "Magnificent Seven" stocks account for nearly a third of the total weight, fell by approximately 1.5%, wiping out around $784 billion in market capitalization.


However, market concerns proved to be short-lived, as U.S. equities managed to recover some of their losses. A Bloomberg survey revealed that 88% of participants saw only limited potential for the Chinese AI startup to negatively impact the Magnificent Seven's performance. Meanwhile, 59% of respondents believed that the primary driver of market volatility this year would be Trump's policies.


Trump is preparing to implement his first tariff action on Saturday, February 1. On Thursday, the U.S. president announced that he would be officially introducing the previously proposed 25% tariffs on Canada and Mexico for several reasons. The primary reason cited was the flow of migrants, while the secondary and tertiary reasons were fentanyl trafficking and large trade deficits.


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Additionally, Trump hinted that the 25% rate could serve as a baseline, with the possibility of further increases over time. He also suggested that he was still considering whether to exempt oil from the tariffs.


Trump further criticized Beijing, stating that China had failed to uphold its commitment to preventing the flow of fentanyl and lethal drug-making chemicals into the U.S. He confirmed that tariffs would also be imposed on China but did not specify a rate.


However, last week, he mentioned a 10% tariff—far below the 60% rate he had proposed during his campaign. Given Trump's tendency to use tariffs as a bargaining tool, the possibility of further hikes remains on the table.


If the new U.S. administration moves forward with tariffs on major trading partners, it could ignite a trade war, increase market turbulence, and have dramatic economic consequences. This uncertainty is further unsettling global markets.


Amid rising uncertainty, the Fed stated in the early hours of Thursday that it plans to keep interest rates steady in the 4.25%-4.5% range for the foreseeable future.


Speaking after the decision, Fed Chair Jerome Powell pointed to several reasons why they were in no rush to cut borrowing costs again. Chief among them was the uncertainty surrounding the policies of the new U.S. president. Powell emphasized that the committee was in "wait-and-see" mode, assessing which policies would actually be implemented.


Following the Fed's decision, Trump took to social media to criticize the central bank and Chair Powell, accusing them of failing to control the inflation problem they had created. As seen during his first term, Trump appears poised to maintain his critical stance toward the Fed.


Nevertheless, Fed officials continue to argue that the overall economy remains in a solid position. They remain committed to holding off on any new moves until they see further declines in inflation. Swap traders have fully priced in a rate cut by the Fed's July meeting, with an 80% probability of a second cut by December. However, the inflation data set to be released later today could significantly impact rate-cut expectations.


According to Bloomberg's survey of economists, the Fed's preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, is expected to have risen to 2.6% in December on a year-over-year basis, up from 2.4% in the previous month.


The so-called core index, which excludes volatile food and energy costs, is projected to have increased by 0.2% month-over-month, while remaining steady at 2.8% on an annual basis.


A report indicating continued price pressures in the U.S. could strengthen the dollar against other currencies. Conversely, a softer inflation reading could reinforce expectations for Fed rate cuts, weighing on the dollar. However, any potential downside for the greenback may be limited ahead of Trump's expected tariff announcements.


Safe-Haven Rush: Gold Nears $2,800 Amid Rising Trade War Fears


Gold prices surged to a historic record in the early hours of Friday, reaching $2,799 per ounce, just shy of the psychological $2,800 threshold. Despite the Federal Reserve's pause on rate cuts, safe-haven demand remained strong, driven by Trump's ongoing tariff threats.


The new U.S. president's tariff rhetoric has the potential to ignite a trade war, fueling concerns over the global economy. Following Trump's re-election in November, expectations that tariffs would push U.S. inflation higher and limit the Fed's ability to cut rates led to a sharp sell-off in gold.


However, since officially taking office on January 20, President Trump has yet to take concrete action on tariffs. While he has adopted a softer stance than initially anticipated, he continues to issue threats. This has led some market observers to speculate that the tariffs may not be as severe as previously promised, putting pressure on the U.S. dollar.


On one hand, a weaker dollar makes gold more affordable for foreign buyers. On the other, heightened uncertainty surrounding Trump's potential tariff actions is bolstering safe-haven demand. As a result, gold prices remain supported despite the still-strong U.S. dollar and elevated U.S. yields.


Gold traders are now turning their attention to today's U.S. inflation data, which could offer further clues about the Fed's policy path. A sticky inflation reading that forces the Fed to maintain its pause for an extended period could weigh on gold's upward momentum.


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Global Central Banks Pivot: More Rate Cuts Amid Economic Pressures


This week, markets witnessed rate cuts from major central banks, in contrast to the Fed's pause. On Wednesday, during its first meeting of the year, the Bank of Canada (BoC) delivered its sixth consecutive quarter-point rate cut, lowering its policy rate to 3%. The decision came as inflation had been brought under control near the 2% target since mid-2024, allowing policymakers to focus on supporting economic growth.


However, Canada's inflation faces the risk of resurging if Trump follows through on his threat to impose 25% tariffs. BoC Governor Tiff Macklem warned that such a trade dispute could severely harm Canada's economic activity while also exerting direct upward pressure on inflation.


Canada is planning to retaliate if the U.S. implements tariffs. However, given the depreciation of the Canadian dollar and the fact that U.S. imports account for approximately 13% of Canada's inflation basket, an inflation spike in Canada seems inevitable.


Across the Atlantic, the European Central Bank's decision was in focus this week. ECB policymakers voted on Thursday to cut rates for the fifth consecutive time, lowering the deposit rate to 2.75%, in response to progress toward the 2% inflation target and the impact of economic stagnation.


Just hours before the decision, data revealed that the eurozone's GDP remained unchanged in the fourth quarter of 2024 compared to the previous quarter. Economists had expected a median forecast of 0.1% growth. Meanwhile, Germany's output contracted by 0.2%, while France's economy shrank by 0.1%.


Eurozone economies are among the primary targets of Trump's global tariff threats, exacerbating uncertainty in the region and denting both business and consumer confidence. Potential tariffs could intensify price pressures in the euro area, but weak economic activity is reinforcing expectations that the ECB will continue cutting rates to support growth.


Traders are now almost fully pricing in three more quarter-point rate cuts from the ECB by year-end. This outlook makes it difficult for the euro, the region's common currency, to strengthen against its biggest rival, the U.S. dollar.


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