C8 Currency Compass – USD Correction – January 2025

 

FX Market and Strategy

The USD has made a strong start to the year, driven by a robust January US employment report, as well as expectations for rate cuts outside the US.  Incoming President Trump has been relatively quiet this month, though that is likely to end after his Monday 20th inauguration.  The key FX driver remains the US import tariff question, though we note that there have been no further developments on that front.

Interestingly, our FX models for USD against EUR, GBP, AUD, NZD and  NOK, which were largely USD positive last year, reversed in January.  In particular, our reversion models are suggesting some strength in these currencies against USD in the near term.  Nevertheless, the continued outperformance of the US economy, alongside sluggish growth in Europe, suggests that any USD reversal will not be sustained.

GBP may prove an exception to this.  Whilst it is as oversold as the EUR, political missteps will generate renewed inflationary pressures in the UK with long-term bond yields back to levels last seen in 1999 (see chart below from Bianco Research).  Importantly, many of the measures in Labour’s first budget only start to impact in the first half of 2025, so we see further upside for EURGBP.

Currency Focus:   Rising Bond Yields Equals Rising FX Volatility

It is not just the UK that has an issue with rising bond yields, though, as discussed overleaf, the issue in the UK has been exacerbated by the lack of confidence in the new government.  The first chart below shows that  10-year bonds yields have risen in all G10 countries, with the exception of Switzerland, since the US easing cycle started in September.  Official interest rates have fallen in most of the countries over this period, yet the steeper yield curve suggests that, at last, fiscal policy matters to markets. Over the 10 years of QE, there was little concern around demand for government debt, which was all but guaranteed by central bank purchases.

This is no longer the case, a key component to our view that FX volatility will increase in 2025.  To illustrate how unusual the recent curve steepening is, the bottom right chart shows how 10-year bonds have performed during all US easing cycles since 1967.  The only case worse than this latest move was in 1981, when US inflation averaged over 10%!  In some respects, the US is less vulnerable than others given they are the biggest beneficiary of the tech revolution. However, fiscal expansion is no longer an option to offset any economic slowdown, forcing hard choices which are already causing political problems in Europe.

Key Event Dates

Mon 20 Jan   US  Pres Inauguration  Return of President Trump

Fri 24 Jan  Japan  BoJ Meeting   Expect 25bp rate hike to o.5% + focus on press conference

Weds 29 Jan  US  FOMC Meeting  Expect unchanged in line with market expectations

Weds 29 Jan  Canada  BoC Meeting  Expect 25bp rate cut to 3%

Thurs 30 Jan  EUR  ECB Meeting  Expect 25bp rate cut to 2.75%

Mon 3 Feb  US  ISM Manufacturing  Expected to keep rising in the first half though may be impacted in Jan by California fires

Weds 5 Feb  US  ISM Non-Man  Expected to keep rising in the first half though may be impacted in Jan by California fires

Thurs 6 Feb  UK  BoE Meeting   Expect 25bp rate cut to 4.50%

Friday 7 Feb  US   Non-farm Payroll  Closely watched after strong Jan figures

Other posts

Thoughts From The Divide: Tricks

BY JON WEBB
Perhaps it’s just us, but as the spooky season returns and jack-o-lanterns bedeck porches, we notice that markets and commentators also seem a bit skittish. Maybe it’s the looming election, or perhaps the geopolitical horror shows, but folk seem surprisingly easy to spook. Case in point was the hullabaloo around the $44bn jump in US (government) debt. The hue and cry of folk such as ZeroHedge were enough to get more mainstream interest, including the owner of X and a son of FP Trump, to take notice. The jump is seasonal, as Constan and others pointed out, rather than some ghoulish trick, but of course it’s easy to make fun of those who took fright. But perhaps this misses the point about horror movies. Some argue that the genre works for some because it allows them to push their boundaries and learn the limits of their fears. If that describes you, we recommend reading the CBO Long-Term Budget Outlook. For others, referred to as “dark copers”, the appeal of horror movies might lie in “anxiety or fear that they’re feeling in their life, and they use scary genres like horror to kind of work through those feelings”. Read more →

NDR Fixed Income Allocation Strategy October 2024 Update

BY BRIAN SANBORN
The NDR Fixed Income Allocation Strategy, Positioning Update Read more →

C8 Weekly Bulletin: The asset class ‘du jour’ – corporate bonds!

BY JON WEBB
The latest Financial Times opinion piece 'The Long View' flags investor interest in an exciting new asset class – not crypto, not AI-driven stocks… but newly higher-yielding corporate bonds! January data on ETF inflows certainly underlined the revived US investor appetite for fixed income with overall inflows running slightly of those into equities. Amid this constructive backdrop, USD and EUR corporate bond markets begin 2023 on a robust note.  Read more →
Back to all posts →