C8 Hedge – Currency Compass – February 2025
FX Market and Strategy
Our FX systems started the year with ashort USD bias (against the general consensus for a stronger USD). For the first three weeks this bias worked well as fears of blanket US tariffs did not materialize, however, in the final week of January, tariffs were announced on Mexico, Canada and China leading to some renewed USD strength. Nevertheless, so far, the measures that have been taken (with some already suspended for now) have not been as bad as feared.
Looking forward to this month, we note the signals are more mixed for the USD though our hedge ratios remain negative USD for the largest currencies: EUR, GBP and JPY.
US tariff announcements remain centre stage as the key event risk, even though we note above that US trade policy changes have been relatively restrained. Nevertheless, our signals point to higher USDCAD and USDMXN over the next month. Also, the EU will be countering US tariffs on EU steel and aluminium exports, their response will be critical to whether this develops into a full scale trade war, our bias remains it will not.
We are also focussed on the shifts in rate expectations as US economic data outperforms the rest of the world. Indeed, coming up in the next few weeks we see rate cuts in Australia, New Zealand and the Eurozone. We look at this issue in more detail overleaf.
To conclude, following the return of President Trump, C8’s FX models show mixed signals against the USD – favouring stronger EUR, GBP and JPY and weaker CAD and MXN. Our key view is that trade policy is being used as leverage on other countries, rather than an end in itself, suggesting fears of a trade war may be overdone, so the USD is still vulnerable to a correction.
Currency Focus: Diverging Interest Rate Expectations
We have long held the view that rising, and now diverging, interest rates in the major economies will lead to increased FX volatility in 2025. This is directly the result of the return of inflation which ended a 10-year period when global rates converged to zero, and central banks engaged in quantitative easing.
The divergence in monetary policy is becoming more important to FX, as seen in the chart below. This shows the futures market’s expectation for overnight interest rates at the end of this year in the US, Eurozone and UK. For the past six months, interest rate expectations have continued to rise in the US, now up by over 1% after yesterday’s strong CPI.
At the same time, Euro rate expectations have oscillated between 1½ – 2% over this period. UK rate expectations rose sharply into year-end on inflation concerns, but have since fallen back on worries over UK growth prospects.
This interest rate divergence will be USD supportive over time. That being said, as discussed on page 1, the USD already strengthened considerably ahead of the return of President Trump and the threat of trade tariffs. Our models are suggesting that a correction to recent USD strength is therefore likely, even against a supportive interest rate backdrop.
Key Event Dates
Tues 18 Feb Australia RBA Meeting Expect 25bp cut to 4.10% after 13 month pause
Weds 19 Feb NZ RBNZ Meeting Expect 50bp rate cut to 3.75%
Thurs 20 Feb China PBoC Meeting Expect Deposit Rates on hold at 1.50%, but easing bias remains
Thurs 6 Mar EUR ECB Meeting Expect Deposit Rate to be cut 25bp to 2.5%
Friday 7 Mar US Employment Key report after weaker Feb NFP