US President Trump's tariff threats roiled the foreign exchange market at the start of last week, but by the end, the market seemed to have taken what many see increasingly as negotiating positions in stride. The dollar had topped out against several of the major currency pairs a week or so before the election as some participants began moving to the sidelines. We anticipated "buy the rumor, sell the fact" type of activity but thought the risk would be less waiting for after the inauguration and the initial chaos. And against most the G10 currencies, the greenback has begun to correct either the rally since the election or since last September's lows.
In the week ahead, the European Central Bank, the Bank of Canada, and probably Sweden's Riksbank will cut interest rates by 25 bp. The Federal Reserve, on the other hand, is on hold. However, the divergence has already been discounted. Meanwhile, the US PCE deflator may pose some headline risk, but the CPI and PPI have already generated the signal of a small gain in the headline and flat core reading. The US and Eurozone report the first estimate for Q4 24 GDP. The median forecast in Bloomberg's survey is for the US to have expanded by 2.6% (the Atlanta Fed's GDP tracker has it at 3%) and the EMU might have eked out 0.1% growth quarter-over-quarter (0.4% in Q3 24). Japan sees Tokyo's January CPI at the end of the week, and it is likely to have accelerated. Australia gets its Q4 CPI reading early Wednesday, and softer numbers would support the market's view that the Reserve Bank of Australia will begin its easing cycle next month. China's Lunar New Year Celebration begins Tuesday, January 28.
US
Drivers: While President Trump's tariff threats roiled the foreign exchange market for a few days, it had a diminishing impact. February 1 has been suggested as a possible, but reports by various cabinet departments are due April 1. Much good news has been discounted. In particular, the Federal Reserve is seen on hold until at least mid-year.
Data/Events: The FOMC meeting concludes a day before the first official estimate of Q4 24 GDP is published. It steals the thunder from remaining Q4 data, including personal income, consumption and deflators that will be reported at the end of week. There is little doubt that the Federal Reserve will stand pat. Chair Powell will likely emphasize that the FOMC is not making any commitment to future meetings and that the central bank is data dependent. He will refrain from sharing any assessment about the policies of the new administration. Some participants will be looking for some guidance on QT, which the Fed has been querying about. We suspect Governor Waller was on message recently when he noted that most of the observable components of the core PCE deflator were rising at a pace less than 2%, while the imputed components, like owner-equivalent rents, are rising at a faster pace. The former is more robust than the later. This will allow the Fed to continue to reduce the restrictiveness of the current monetary setting. The Atlanta Fed's GDP tracker puts Q4 GDP at 3.0%, while the NY Fed's model and the median in Bloomberg's survey converge at 2.6%. With the CPI and PPI in hand, economists expect the headline PCE accelerated last month to a 2.5% or 2.6% year-over-year pace, from 2.4% in November, depending on the rounding. The core rate appears steady at 2.8%.
Prices: The Dollar Index peaked on January 13, a week before the inauguration. Still, we recognized risks in the early days of Trump's second term, though we recognized the likelihood of "buy the rumor sell the fact" type of activity. That seems to have indeed emerged. The dollar's technical tone has weakened. The five-day moving average has fallen below the 20-day moving average and the momentum indicators have turned down. The Dollar Index fell was sold through a potential neckline of a head and shoulders top around 107.75, which projects toward 105.25. The (50%) retracement of the 10% rally since the end of September is near 105.15. The first retracement (38.2%) is about 106.35.
EMU
Drivers: The euro seems less sensitive to European developments and more sensitive to the broad movement of the US dollar. Yet, the somewhat stronger than expected preliminary PMI helped to spur the push higher ahead of the weekend. Momentum traders and trend followers have been in control for a few months and appear to be covering shorts.
Data/Events: The eurozone may have eked a slight expansion in Q4 24, but it is unlikely to be more than half of the 0.4% growth in Q3. It will be in hand when the European Central Bank meets on January 30. As certain as the market is that the Fed is on hold, it is as convinced that the ECB will cut its key rates by another 25 bp to 2.75%. While President Lagarde may not want to pre-committal, but she will likely validate market expectations for lower rates. The swaps market is discounting nearly 100 bp of cuts this year with nearly 75 bp priced for the first half.
Prices: With the pre-weekend gains, the euro reached $1.0520, its highest in a month and about 3.3% above the low slightly below $1.0180 on January 13. The momentum indicators are moving higher and the five-day moving average crossed above the 20-day. The euro met the (38.2%) retracement of the losses since the US election (~$1.0470). The next technical target is the $1.0560-75 area, which holds the (50%) retracement of the post-election losses and the (38.2%) retracement of the losses since last September. However, a move now below $1.0375 would be disappointing and raise the possibility that the upside correction has run its course.
China
Drivers: Chinese officials closely manage the exchange rate. The setting the daily reference rate and not permitting trades outside of the approved band (2% for the dollar) is the primary tool. This coupled with platforms that reject trades that are implied to violate the range and influencing liquidity are also important tools. Actual material intervention by officials directly or indirectly seems superfluous except for perhaps some signaling value.
Data/Events: China's "official" PMI will be reported on January 27 and the Lunar New Year Holiday begins the following day. Mainland market will be closed January 28 through February 4, inclusive). Still, on January 31, Caixin will report its iteration of the manufacturing PMI.
Prices: Beijing has not shown willingness to let the yuan fall in the face of US tariff threats. In fact, by lowering the reference rate, the PBOC effectively supports the yuan above its recent lows. Officials have also taken steps to support the equity market, which seemed to have begun paying off at the end of last week. The greenback saw its lowest level since the end of November ahead of the weekend (~CNY7.2375). The dollar fell by about 1.25% against the offshore yuan last week, the largest weekly loss since the unwinding of carry-trades in late July/early August 2024. It neared CNH7.2345. The CNH7.23 area corresponds to the (50%) retracement of the dollar's gains since the US election. The 200-day moving average and the (38.2%) retracement of the dollar's rally since the end of September is around CNH7.2170.
Japan
Drivers: If there were only one variable one could use to get a handle of the yen's exchange rate, it would be the 10-year US Treasury. A rolling 60-day correlation between changes in the exchange rate and US 10-year yield is now and typically a little higher than the correlation of the spread between 10-year JGBs and Treasuries. The BOJ hiked its overnight rate by 25 bp last week and is now seen on hold until at least Q3.
Data/Events: Japan's calendar is light until the end of the week. Then the deluge: employment, industrial production, retail sales, and Tokyo's January CPI. With a rate delivered, the high-frequency data may post headline risk but the impact on the policy outlook is marginal.
Prices: While the dollar is correcting lower against most of the G10 currencies, it continues to move sideways against the yen. Since January 16, the dollar has traded between approximately JPY154.80 and JPY156.75. Neither the dollar's volatility since the inauguration nor the BOJ's quarter-point hike and upward revisions to its inflation projections were sufficient to trigger a breakout. The momentum indicators are falling but look to turn higher in the coming days. A loss of JPY54.80 could spur another yen decline. An upside extension of the range may target JPY157.30 initially, but possibly JPY158.00
UK
Drivers: Sterling fell almost 10% between the end of September and January 13 when it bottomed near $1.21. Domestic considerations are not particularly supportive of sterling, but much has been discounted, and the Chancellor of the Exchequer Reeves appears to be willing to reconsider some unpopular positions. Growth is slower and the budget deficit larger than expected since Labour came to power last summer.
Data/Events: The UK reports consumer finance numbers, like credit, mortgages, and house prices in the coming days. The data are unlikely to change the market conviction that the Bank of England will cut the base rate a quarter of a point at next week's Monetary Policy Committee meeting. The swaps market sees a good chance of another cut in Q2, but only has about 15 bp in cuts in H2 25. This seems too cautious.
Prices: Sterling has appreciated by about 3% since testing $1.21. It briefly popped above $1.2500 before the weekend, reflecting the dollar's broad pullback. Sterling's short-covering rally met the (38.2%) retracement of the drop since the US election. The next retracement (50%) is near $1.2575, which is also the high so far this month. The momentum indicators are moving higher and the five-day moving average crossed above the 20-day at the end ahead for the weekend. Above $1.2575, the $1.2610 may attract interest, which is the (38.2%) of the large decline that began in late September.
Canada
Drivers: Canada is seen as among the most vulnerable to a new US push toward re-shoring. The Bank of Canada also has been among the most aggressive in this easing cycle. The political situation is fluid as the Liberals will chose Trudeau's successor in March. It is not clear that the new leader will survive a confidence vote, which Trudeau was set to lose, or whether elections can be forestalled until they are required in early Q4.
Data/Events: The Bank of Canada meets on January 29. It cut the overnight lending rate by 175 bp in 2024, starting in June, and including two half-point moves at back-to-back meetings in Q4 24. Of the 15 economists surveyed by Bloomberg, all but one anticipate a rate cut now. The swaps market has about a 90% chance of a quarter-point cut discounted. It would follow two half-point cuts at the end of last year.
Prices: The US tariff threats injected volatility in the exchange rate, but by the end of the week, the US dollar was almost 1% lower, which is the largest weekly loss since last August. A break of the CAD1.4260 area could spur a move toward CAD1.42. The momentum indicators have fallen more than the price action might suggest. Still, the larger corrective forces may dominate and there may be potential toward CAD1.41, especially if the Bank of Canada hints that a further slowing of the relatively aggressive easing cycle may be appropriate.
Australia
Drivers: The Australian dollar seems sensitive to the broad direction of the US dollar, and changes in the exchange rate are also sensitive (correlated) to the changes in the two-year interest rate differential. Its correlation with a basket of commodities, such as the CRB index is less than with the Dollar Index, the US two-year yield, and the US-Australian two-year interest rate differential. In fact, changes in the exchange rate are more correlated to changes in the price of gold than to the CRB index over the past 60 days.
Data/Events: The Reserve Bank of Australia meets on February 19 and this week's data will likely help shape expectations. Currently, the futures market has about 2/3 of the first cut discounted. The central bank puts more weight in the long time series of the quarterly CPI measure than the newer monthly iteration. The Q4 estimate is due January 29. The headline may prove a little sticky, but the underlying measures may have softened. December private sector credit the next day could play on the RBA's fears that the demand continues to outstrip supply and accelerate from November 6.2% year-over-year pace.
Prices: The Aussie took out the downtrend line drawn off the late September highs at the start of last week near $0.6235 and rallied nearly a cent by the end of the week. It rose for the second consecutive week, and last week's 2.1% advance was the best weekly showing since November 2023. The momentum indicators are approaching overextended territory, but they have not begun turning. The next technical target is around $0.6400 and then $0.6440.
Mexico
Drivers: Mexico seems vulnerable to the new US administration. President Sheinbaum seems prepared to levy higher tariffs, including on Chinese imports, with the goal in mind to replace imports with domestic production. Sheinbaum is popular in Mexico, but she has yet to win over investors. The 10% overnight rate in Mexico makes it expensive to short against the dollar, which forces momentum traders to quickly exit when the peso stops falling like it has in recent days.
Data/Events: Mexico reports December's trade balance on January 27, unemployment on January 29, and Q4 GDP on January 30. Mexico recorded a nearly $10.8 bln trade deficit in the first 11 months of 2024 compared with a $9.7 bln shortfall in the Jan-Nov 2023 period. However, what does not set well in Washington now is that Mexico runs a substantial trade surplus with the US. In the first 11 months of 2024, Mexico had a trade surplus of $157.2 billion with the United States, a 12.5% increase compared to the $139.69 billion surplus recorded in the same period of 2023. Mexico's growth likely slowed to a more sustainable path after surging by 1.1% in Q3 23. In the previous four quarters, the Mexican economy expanded by an average of about 0.3%.
Prices: The dollar has fallen in eight of the last ten sessions against the Mexican peso. The peso losses initially suffered in reaction to the US tariff threats have completely been recouped. In fact, ahead of the weekend, the US dollar recorded a new low for the month slightly below MXN20.1350. The dollar fell by about 2.5% against the peso last week, its largest decline since last September, and the first weekly decline since the week before Christmas. In the region, the Colombian peso (~3.7%) and the Brazilian real (~3.2%) outperformed the Mexican peso. The peso's recovery has seen the swap market move to price in more a quarter-point cut at the February 6 meeting. Meanwhile, Brazil's central bank has already signaled its intent to hike the Selic rate by 100 bp at the January 29 meeting (to 13.25%).
Reviewed by Marc Chandler
on
January 25, 2025
Rating:
