Sterling woes persist

Tariff Fears Weigh on Peso and Loonie

Investors were on edge yesterday as global markets began the week with a mix of optimism and uncertainty following Donald Trump’s inauguration for a second term. Reports and comments from the president himself about the United States considering steep tariffs on Mexico, Canada, and China sent ripples through financial markets, raising questions about how global trade dynamics might shift in the months ahead. Foreign exchange traders reacted swiftly, with the price of options products betting on further Canadian dollar weakness climbing to its highest level in two years.

In Europe, investors took some solace in the fact that no immediate tariffs had been introduced, though concerns about the future persist. Meanwhile, Chinese officials sought to reassure markets about economic stability as growth remains fragile. Despite these uncertainties, equity benchmarks across the developed world managed to edge higher, supported by robust corporate earnings, which helped offset fears surrounding trade policy. Longer-term bond yields continued to decline, offering welcome relief to currency markets, which had been contending with a stronger dollar until last week.

The US Dollar Index is already on track to decline for a second consecutive week, a trend last observed in September 2024. As the year progresses, markets are bracing for heightened volatility. With trade policy, central bank decisions, and geopolitical risks all in play, investors are navigating a complex macroeconomic landscape where any policy surprise could trigger sharp market movements.

Animal Spirits Push the Euro Beyond $1.04

Investor sentiment towards the European economy has been overwhelmingly negative, with fears of recession, weak growth prospects, and ongoing geopolitical risks dominating the narrative. However, much of this pessimism is already reflected in asset prices, creating an environment where the bar for positive surprises is exceptionally low.

This was underscored by yesterday’s ZEW investor survey, in which zero percent of participants described the Eurozone economy as being in good shape. The German sentiment index fell more than expected, remaining in deeply negative territory. This asymmetry in expectations means that any upside surprise in economic data—be it stronger-than-expected growth, resilient consumer spending, or even a modest improvement in business confidence—could provoke an outsized market reaction this year.

Such developments could have significant implications for the euro in the medium term. For now, however, its rally is being driven by market sentiment and dollar weakness, as investors respond to Trump’s decision to delay immediate tariff hikes. EUR/USD extended Monday’s gains, pushing beyond the $1.04 mark, with last week’s lows of $1.02 already fading into memory. Nevertheless, as the pair climbs higher, selling pressure is likely to increase, given the Eurozone’s continued vulnerability to potential US tariffs.

Sterling Still Stuck in a Downtrend

The British pound is currently 2% higher than its recent one-year low against the US dollar. Its recovery from $1.21 faltered just below the $1.24 threshold, leaving the downtrend that began in October intact. Although sterling has benefited from this week’s broadly weaker dollar, ongoing concerns about UK stagflation—characterised by persistently high inflation and stagnant economic growth—continue to weigh on the currency.

On Tuesday, data revealed that wage growth accelerated to a six-month high in the three months to November, aligning with expectations. However, the unemployment rate unexpectedly rose to 4.4%, alongside the steepest drop in payroll numbers since November 2020, hinting at potential softening in the labour market. While higher wages prompted traders to slightly scale back rate expectations, the likelihood of a rate cut at the Bank of England’s (BoE) February meeting remains above 80%. Sterling appears to be caught between a rock and a hard place. Its current negative correlation with rates and yields reflects concerns about the UK’s slowing economic growth and rising government debt burdens. Yet, stronger signals from the BoE about the need for interest rate cuts would likely further weaken sterling due to its impact on yields.

For the pound to stage a sustainable recovery against its peers, including the euro, UK economic data will need to show improvement alongside greater confidence in fiscal policy. This morning’s data, indicating that the UK government borrowed more than expected in December, highlights the significant challenges facing Chancellor Rachel Reeves.

Trump's in ... Brace yourselves!

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.

Trumps big day

GBP remains under pressure against both the Euro and the US Dollar as it navigates a challenging week. Against the Euro, Sterling has entered a technical downtrend, with the exchange rate currently at 1.1850 after three consecutive weeks of losses. A break below the 200-day exponential moving average (EMA) last week signals the potential for a sustained decline, as this technical level now acts as resistance. Tuesday’s UK labour market report is a critical event, with rising unemployment and wage data likely to shape market sentiment. Should the data reveal a weaker-than-expected labour market, expectations for further interest rate cuts from the Bank of England may deepen, exerting additional downward pressure on the Pound.

Similarly, GBP/USD remains vulnerable, consolidating around 1.22 but retaining a negative technical outlook. Momentum indicators suggest further losses are likely, with downside targets of 1.21 and potentially 1.1850. The Dollar’s movements will also hinge on US political developments this week, with markets closely watching President Trump’s inaugural policy announcements. The interplay of UK-specific economic challenges and global risk sentiment makes for a volatile environment for Sterling traders.

This week marks the inauguration of Donald Trump as the President of the United States, an event that is set to dominate global market sentiment. Traders are particularly focused on Trump’s initial policy pronouncements, especially on tariffs, taxes, and immigration. A blanket tariff on imports could strengthen the Dollar, as it would likely drive inflation higher and prompt the Federal Reserve to maintain elevated interest rates. However, a more measured approach to trade policies could weaken the Dollar, providing some relief for the Pound and Euro.

Markets remain cautious, with global stocks consolidating ahead of concrete policy announcements. The uncertainty surrounding Trump’s economic agenda adds another layer of complexity for foreign exchange markets, making this a pivotal week for the US Dollar and broader global markets.

Shock Decline in December UK Retail Sales

British Pound Falls as Shock Decline in December Retail Sales Raises Economic Concerns

The British Pound weakened against the Euro, Dollar, and other currencies following the release of disappointing retail sales data for December by the Office for National Statistics (ONS). The Pound to Euro exchange rate dropped from 1.1872 to 1.1842, while the Pound to Dollar exchange rate fell from 1.2215 to 1.2185.

Retail sales declined by 0.3% in December, contrary to market expectations of a 0.4% increase, a significant setback during what is typically a critical month for the UK’s retail sector. Year-over-year growth in sales reached just 3.6%, well below the anticipated 4.2%. The primary driver of the decline was a 1.9% drop in food store sales, which pushed the sector to its lowest point since April 2013.

This unexpected slump underscores the challenges facing UK consumers, signalling risks to economic growth in the coming months. Broader economic pressures have intensified since the Labour Party's election victory in July, with policy changes such as tax hikes, minimum wage increases, and added regulatory burdens contributing to a decline in business sentiment and consumer activity.

Retailers are struggling to absorb rising costs, particularly as National Insurance tax rates and thresholds are set to increase in April alongside a second consecutive year of above-inflation minimum wage hikes. These pressures are especially acute in the retail sector, which is a significant employer of minimum-wage workers.

The broader economic outlook remains subdued. Economic growth for November was just 0.1% month-on-month, missing expectations, while inflation in December came in slightly below forecasts. The slowing retail activity adds to evidence of weakened demand, likely reinforcing the Bank of England's confidence in managing inflation.

Market sentiment now suggests an almost certain interest rate cut by the Bank of England in February, with the possibility of three additional cuts throughout the year. Analysts caution that the Pound’s decline in 2025 reflects the compounded impact of these economic and fiscal challenges, as the UK continues to navigate a period of adjustment and uncertainty.

EUR/USD Fluctuates Amid Mixed US Data and Fed Signals

The EUR/USD pair experienced notable volatility in yesterday’s trading session as investors digested a mix of US economic data and commentary from the Federal Reserve. After an early attempt to extend gains, the euro lost ground against the dollar, reflecting ongoing uncertainty in global markets. Despite the pullback, the pair remains poised to achieve its first positive weekly performance in seven weeks.

The economic data presented a mixed picture. While jobless claims suggested potential softening, stronger figures from the retail sales control group and an impressive Philly Fed manufacturing report indicate signs of resilience. The manufacturing sector, in particular, appears to be rebounding, signalling a potential turning point in economic momentum.

Initially, both US Treasury yields and the dollar were on the rise. However, dovish remarks from Federal Reserve Governor Waller shifted the narrative. He suggested the possibility of rate cuts in the first half of 2025 and actively encouraged markets to consider this scenario. In response, the dollar weakened broadly, and Treasury yields fell by 3-5 basis points across the curve as investors unwound short positions.

Market sentiment also adjusted in anticipation of political shifts, including expectations surrounding Trump’s return, further contributing to the greenback's decline. These developments underscore the delicate balance of economic and political factors influencing currency markets.

UK Economy Faces Stagflation

UK Economy Faces Stagflation and Falling Sterling Amid Economic Struggles

The UK economy is entering a challenging period of low growth and high inflation, a combination often referred to as stagflation, which poses significant risks for the British Pound (Sterling).

Sterling weakened against the Euro and the Dollar following data from the Office for National Statistics (ONS) revealing that the UK economy expanded by just 0.1% month-on-month in November, falling short of the expected 0.2% growth. This brought the annual growth rate down to 1.0%.

The Pound to Euro exchange rate dropped to 1.1864 in response, erasing more than half of the prior day's rally, which had been driven by lower-than-expected inflation figures in both the UK and the U.S. The Pound to Dollar exchange rate also declined, trading at 1.2206, down 0.20% on the day, with downward momentum firmly in place.

This economic stagnation is unwelcome news for Chancellor Rachel Reeves, who is relying on growth to bolster government revenues and fund increased spending over the next four years. However, market concerns about the UK’s debt sustainability in the absence of economic growth have triggered a selloff in UK bonds and Sterling.

While the UK was the fastest-growing G7 economy in the first half of the year, it has since faltered. According to the ONS, the economy showed no growth in the three months to November 2024 compared to the previous three months. Modest positive contributions from the services sector (+0.1%) and construction (+0.3%) in November were offset by a 0.4% decline in production output, following a 0.6% drop in October.

Prime Minister Keir Starmer and Chancellor Reeves have emphasized the need for "tough decisions," including tax increases, which have strained businesses and households. The subsequent budget measures have led to reduced business spending, higher prices, and job cuts. The resulting slowdown in economic activity threatens to lower tax revenues, potentially forcing further tax hikes and spending cuts, exacerbating already low consumer and business confidence.

With these challenges looming, the outlook for the British Pound appears equally bleak, as markets grapple with the economic and fiscal uncertainty facing the UK.

Inflation Data Sparks Optimism in Financial Markets

Financial markets have reacted sharply to inflation concerns, with even minor data surprises fuelling bullish sentiment in equities and bonds. The US dollar declined for the third consecutive day as investors embraced two weaker-than-expected inflation reports this week—core CPI and core PPI.

The recent dip has offered investors an opportunity to take profits after weeks of upward pressure on the Greenback. The broader upward trend in the US Dollar Index (DXY) remains intact, provided it stays above the 108.60 level. Meanwhile, the US 10-year Treasury yield is on track to record its second-largest daily decline of the year.

Despite these developments, inflation trends remain a mixed picture. Broad measures of inflation are still edging higher as reflationary pressures re-emerge. Encouragingly, declines in core, shelter, and services inflation provide some relief, but sustained improvement is crucial. Consistent downward trends in inflation over the first quarter of the year—similar to this week’s data—would bolster confidence in the Federal Reserve’s policy trajectory.

Investors, however, have little time to focus solely on inflation data as attention shifts to key economic releases scheduled for today. Reports on retail sales, initial jobless claims, the Philly Fed Manufacturing Index, and the NAHB Housing Index are set to provide further insights.

Retail sales are anticipated to show strong performance, driven by robust holiday shopping and increased car sales, as consumers likely frontloaded spending ahead of anticipated tariff hikes under the Trump administration. These factors should help stabilize market sentiment and limit downward pressures for the remainder of the week.

Euro Struggles Amid Weak Economic Outlook Despite US Data

The euro was poised for a third consecutive day of gains against the US dollar, buoyed by weaker-than-expected US data. However, bearish sentiment during the US session pushed EUR/USD lower, falling from $1.0350 to below the $1.03 level. Unlike the pound, yen, or yuan, which have managed to leverage softer US economic indicators, the euro continues to face significant challenges, largely due to Europe’s fragile economic growth outlook.

Eurozone inflation ticked higher in December but did little to influence the European Central Bank’s (ECB) current policy trajectory. Both ECB Chief Economist Philip Lane and Vice President Luis de Guindos reiterated the need for further rate cuts. With the deposit rate currently at 3% and the neutral rate estimated between 2% and 2.5%, policymakers still have room to lower rates as necessary.

The broader macroeconomic landscape offers little optimism. While Eurozone industrial production increased for the second month in a row with a modest 0.2% rise in November, this growth is insufficient to counter the region’s economic stagnation. Germany, the Eurozone’s largest economy, continues to weigh heavily on the region’s prospects, having contracted for a second consecutive year in 2024—a first since 2003. With the 2025 outlook equally bleak, concerns about Europe’s economic trajectory persist, keeping the euro under pressure.

Please note:  The news and information contained on this site should not be interpreted as advice or as a solicitation to offer to convert any currency or as a recommendation to trade.

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