Thin Liquidity, Strong Price Action
Recent headlines from The Washington Post and The Wall Street Journal, coupled with Trump’s recent call with Xi, have suggested that the new administration may adopt a more measured approach to tariffs than initially feared. The previously promised tariff hikes on day one of his presidency have not materialised. Investors welcomed the delayed tariff implementation, and while US markets were closed, futures trading and price movements in Europe and Asia reflected the positive sentiment with higher equity prices.
Although uncertainty persists, this development aligns with our initial presidential preview published in July, where we anticipated that Trump’s approach might not be as aggressive as markets had priced in. With no immediate catalysts to drive a significant rise in the dollar, market exhaustion could set in, especially if Trump’s policy stance and the Federal Reserve’s expected pause are already fully factored in.
However, Trump has made it clear that he will not entirely abandon his protectionist agenda. The president has announced plans to impose a 25% tariff on Canada and Mexico from 1st February. Whether this will actually be implemented remains uncertain. Nonetheless, this announcement was enough to help the dollar recover some of its earlier losses on Monday and to prompt a decline in equities. At present, uncertainty and volatility appear to be the only constants.
Fewer Reasons to Sell the Euro
The euro saw a significant rally against the US dollar, marking its best performance of the year so far. This upward movement was driven by reports that Trump would delay imposing new tariffs on his first day in office. These reports suggested that tariff hikes might go through Congress rather than being implemented via executive orders, alleviating immediate market concerns. With US markets closed for Martin Luther King Jr. Day, thin liquidity amplified the price movements.
While we maintain a mildly optimistic medium-term outlook for the euro, a repeat of its 2016 rally would require a more robust domestic macroeconomic backdrop. Meanwhile, currencies such as the Chinese yuan and the Mexican peso remain more vulnerable, given the potential for new export controls on China and stricter US immigration policies toward Mexico. The first few months of Trump’s presidency will be critical in shaping market sentiment. Should his protectionist bias dominate, volatility is likely to remain high. Conversely, a more pragmatic approach could lead to a repricing of risk across global markets.
Although Trump is expected to champion trade protectionism and economic nationalism, the key question is how aggressively he will pursue this agenda. The heightened uncertainty that once justified selling the euro is no longer a given, as much of the anxiety has already been priced in over the past four months. Monday’s price action, which saw a weaker dollar, could offer a glimpse of what’s to come in 2025 if Trump fails to deliver strong hawkish measures soon.
Pound’s Rebound Could Be Short-Lived
The pound experienced its best day of the year against the US dollar yesterday, buoyed by the news that Trump was holding off on his sweeping tariff plans. Higher-beta currencies—those more sensitive to changes in overall market or economic conditions—outperformed, benefiting more than traditional safe-haven currencies. As a result, the pound appreciated against the US dollar, Japanese yen, and Swiss franc but weakened against the Swedish krona, Norwegian krone, Australian dollar, and New Zealand dollar. The euro also outperformed sterling, with GBP/EUR slipping to €1.18, its lowest level since August 2024. Nevertheless, the currency pair remains in the upper third of its two-year trading range and two cents above its five-year average.
The positive reaction to the tariff delay proved short-lived, as Trump’s subsequent announcement of potential tariffs on Mexico and Canada by the end of the month unsettled markets. Conflicting signals caused currency markets to fluctuate wildly, with GBP/USD retreating below $1.23 this morning. With so many unknowns, it is difficult to call an end to the recent dollar rally, and volatility appears to be the only certainty over the coming weeks and months.
In addition to these external drivers, domestic UK data has come under scrutiny this week. This morning’s UK labour market report revealed that average weekly earnings for November were lower than expected at 5.6%, compared to forecasts of 5.7% and the previous reading of 5.2%. However, the figure excluding bonuses was slightly better than expected, at 5.6%. This data follows recent reports that have raised concerns about economic stagnation, with inflation easing in line with the Bank of England’s (BoE) estimates, GDP growth stalling, and retail sales disappointing.
Traders are anticipating at least two quarter-point BoE rate cuts this year, but given the recent data, this outlook may be overly conservative. Policymaker Alan Taylor recently suggested that the Bank could consider cuts of up to 125-150 basis points if downside risks materialise. This poses a significant headwind for the pound, which could see its appeal further eroded, leaving the $1.20 level as a key downside target for FX traders in 2025.
