Global Head of Macro Strategy
Summary: Markets have spent much of the last weeks of 2024 trying to understand the impact of Trump 2.0. In the final post of 2025, we look at the key questions for the incoming Trump administration and other top-of-mind issues in FX as the New Year rolls into view.
The week that was: new highs for USD, new lows for JPY on contrasting central bank performances
The US dollar jumped to new highs for the cycle this week on a hawkish ready of the FOMC, although as I pointed out in my initial reaction piece, it was less about the Fed’s staff economic projections and moving its dot plot of projections to show one less rate cut next year than the market expected it to, and more about the Fed making clear what the market already knows: that the Fed has little visibility on the economy and therefore its eventual policy, that its forward guidance isn’t worth much in an era of increasing fiscal dominance, and that the Fed will be in reaction mode to whatever Trump 2.0 delivers from January.
The JPY was booted sharply lower on the combination of US treasury yields applying pressure on the one hand, and on the other the Bank of Japan once again demonstrating indecisiveness, as Governor Ueda signaled the bank wants to see more incoming data – particularly the annual wage rounds in March before resuming its hiking regime. This has the market punting rate hike expectations to the March meeting. That timing does make some sense: it will give the BoJ and Japanese government some time to assess the impact of the incoming Trump administration. As well, PM Ishiba has outlined the fiscal agenda since taking office in November, but his LDP doesn’t have the majority in the key lower legislative house, so the fiscal agenda is not fully formed and the Diet session doesn’t begin until January 24, the same day that the BoJ meets. Until then, traders will have to navigate JPY crosses with a constant intervention threat – one warning from Japan’s ministry of finance already helping to cap the action overnight (with hefty risk off in Friday’s European session also capping global bond yields and driving some JPY resilience, by the by.)
Elsewhere, the Bank of England waxed dovish, with three dissenting dovish votes calling for a rate cut as the bank decided to hold rates at a G10 high of 4.75% yesterday. BoE Governor Bailey said that it’s right for the bank to remain on its “gradual approach to future interest-rate cuts”, and the BoE policymakers said they would look through the recent strong wage data (positioned as merely “volatile” and stay on course with its intent to gradually reduce rates. EURGBP is the pair to watch on the shape of sterling from here as discussed in this week’s chart focus below, although note that GBPUSD has also been interacting with a key sub-1.2500 support as well.
Norges Bank also kept rates unchanged and there was nothing interesting in the guidance, which is inline with market thinking on a slow cutting cycle to begin next year, though projecting three cuts starting in March versus market consensus of four. But Norwegian short rates settled almost unchanged on the day and NOK’s sharp weakening perhaps more a function of very weak risk sentiment than due to Norges Bank.
The Riksbank guided hawkish relative to expectations as it cut another 25 basis points to 2.50%. Its guidance was that it “may” hike once more in the first half of next year, while it raised the core inflation forecast for next year to 2.0% from 1.6% previously. This justifiably sent EURSEK sharply lower as 2-year Swedish rates jumped more than 10 basis points, with the back-up in EURSEK today erasing much of the move possibly due to weak risk sentiment.
Chart: EURGBP
EURGBP grazed the cycle lows near 0.8225 again yesterday before launching a steep rally on the more dovish than anticipated Bank of England. It’s not enough yet to seal the deal, but if we work back into the 0.8350-0.8400 zone, the downtrend will look severely disrupted and may have ended at that point.
Top of mind in the transition to 2025:
Normally I reserve considerable space for a rundown for the week ahead in event risks. But given we are on the other side of all of the urgent event risks for the year, there is little point, and I will return with the FX Update on January 3 or January 6. Rather, I’ll leave 2024 asking a couple of what I feel are the most important questions for the coming weeks and the coming year as a whole.
The key for 2024: Trump agenda and what comes first?
Most urgently suddenly is the US government shutdown risk. US president-elect Trump is making increasingly large waves in setting the agenda even a month before his inauguration. In the last couple of days Trump demanded that Republicans vote down a bi-partisan spending bill that was set to pass a vote in the House. In part egged on by Elon Musk, Trump argued that the bill included too many wasteful spending measures to please Democrats and he demanded a “clean” bill and – a kicker – that Congress also vote to raise the US’ self-imposed debt ceiling to get it one “on Joe Biden’s watch”. A new bill was floated yesterday but was rejected by the Democrats and a minority of Republicans.
Longer term: DOGE and deregulation, tax cuts and tariffs.
There are three possible factors that can theoretically support the US dollar with the incoming Trump administration. These are tariffs, which in theory make access to US dollar abroad more difficult and raise the odds that US inflation will remain high, obviating further Fed easing. Deregulation and tax cuts should juice growth, likewise keeping Fed policy rates higher than otherwise. Then there is the DOGE, or Musk/Ramaswamy’s Department of Government Efficiency, which seems to have made its first coup in striking down a spending bill even before Trump becomes president. If the DOGE proves a wrecking ball upon Trump taking office, striking down considerable Biden-era green- and other spending, this is a powerful USD negative, depending on the net scale of fiscal spending reduction (i.e., vs. the tax cuts and deregulation, which are less directly stimulative in the case of the former.) By the way, one of the interesting watchwords in this regard is “impoundment”, whether the Trump administration can stop funds that have been committed to specific Biden initiatives from being spent.
US Treasury yields are another existentially important factor for the US dollar and an independent variable that will require a policy response if they get disorderly. Intervention to keep the treasury market orderly could disrupt any USD-positive effects of new supply-side reform or tariffs.
How especially China responds to the arrival of Trump.
No visibility here, but there are very different directions that the policies of what Trump calls the “G2” (US and China as the only important players on the global stage) can take from Trump’s January 20 inauguration. Do we get an immediate and rapidly deepening trade war if Trump imposes massive tariffs against China and China retaliates in kind and even devalues its currency? Or do we see a period of negotiations and headline threats followed by real attempts a deal-making. What could this look like? Possibly a revaluation higher in the renminbi in exchange for Trump not imposing tariffs and some kind of coordinated devaluation of the US dollar (the so-called Mar-a-Lago accord approach). The latter, by the way, is the best way to fulfill US Treasury Secretary’s vision of keeping the US dollar’s status as the primary global reserve currency – a stronger and weaponized US dollar accelerates the motivation to find alternatives.
Other urgent issues:
CAD weakness. It’s easy to support the case for a weak CAD when we note the BoC’s more dovish path, Canada’s weak growth and the risks of the imposition of tariffs. From the rate spread angle, I don’t see much further more room for a widening of the spread, especially with BoC’s Macklem now waxing far more cautious on the rate path. On the 25% tariff against both Canada and Mexico that Trump floated, could Trump’s bark prove worse than his bite? Unknown, although Trudeau folding his tent and a snap election would put Canada in a much better place politically for the Trump era, as the Conservatives are polling strongly and their leader Poilievre is sending the right signals on deal-making. So by February, USDCAD could be above 1.5000 or sub 1.40 depending on how all the above chips fall. Positioning is very stretched short the loonie – call and put spreads possibly the only way to trade a view in USDCAD, given volatility risks from headlines in the coming few weeks.
Sterling turning lower? The Bank of England made it clear that it intends to continue for now with an gradual easing path and UK short rates judged this dovish as noted above. EURGBP has staged an interesting recovery, once again, from critical levels just ahead of the 0.8200 post-Brexit referendum vote low. Watching early days of 2025 for whether this holds and sterling risks downside on a more stagflationary outlook while Europe stumbles along or even sees its outlook brighten.
Watching Germany and Eurozone ahead of Feb 23 Germany election.
The CDU/CSU opposition to the current government has been making some of the “right” noises on the need to change the attitude on fiscal policy and open up for more investment, but are we set for a real revolution in Germany’s stance on fiscal stimulus and striking out on a new path now that its old industrial/export model has been completely disrupted, or do we get cautious incrementalism? I hope for the former, but fear the latter, especially if the CDU continues to see the AfD as untouchable, requiring it to partner with the left-centre SPD in an unwieldy coalition. Then there’s France…no clarity coming there any time soon – keeping an eye on Germany-France spreads. The single Eurozone-wide issue of greatest interest is whether there is a path to opening up for proper Eurozone bonds to fund defense spending, possibly on the order of EUR 1 trillion. And then there is dealing with Trump tariff threats and wherever the Ukraine-Russia war is going.
Table: FX Board of G10 and CNH trend evolution and strength.
Note: the FX Board trend indicators are only on a relative scale and are volatility adjusted. Readings below an absolute value of 2 are fairly weak, while a reading above 3 is quite strong and above 6 very strong.
The USD strength and NZD weakness has made for spectacular moves in NZDUSD as seen in the individual pairs below. Silver weakness sticks out and fits with the Aussie weakness as well as the market has given up on China stimulus hopes for now.
Table: FX Board Trend Scoreboard for individual pairs.
Some spectacular trend readings in the USD/commodity dollar pairs – these are looking very stretched, but if the current bout of risk aversion deepens badly, the US dollar can continue to extend before something gives.
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