Sterling Under Pressure: GBP Faces Persistent Declines Amid Dollar Strength and Domestic Challenges

The British pound has recorded five consecutive daily declines against the US dollar. From October 2024 to yesterday, GBP/USD has managed only 29 positive days and lost nearly 10% of its value. The primary driver behind this trend is a broadly stronger US dollar. However, renewed negative structural factors, including rising UK long bond yields, have further exacerbated the pound's downtrend.

Looking ahead, the outlook for sterling remains challenging. Traders are focusing on the psychological $1.20 mark as a key downside target. While the relative strength index indicates oversold conditions that could trigger a short-term rebound, a sustained recovery hinges on a reversal of the positive US dollar narrative—a scenario that appears unlikely given the steady flow of positive news from the US. Domestically, any meaningful recovery depends on improvements in the UK economy and an effective fiscal response to escalating debt-repayment costs.

A key event this week is the UK inflation report, set for release on Wednesday. Unfortunately for the pound, the outcome might prove unfavourable regardless of the data. Persistently high inflation could delay Bank of England (BoE) rate cuts, adding pressure to the strained gilts market and widening the gap between yields and sterling. On the other hand, a softer inflation reading could ease bond-market stress but also lower short-dated GBP interest rates as markets price in additional BoE easing, which might weigh on the pound further.

Rachel Reeves is set to deliver a statement on her recent trip to China, but opposition parties are expected to seize the opportunity to question her about ongoing market anxieties surrounding the surging cost of UK debt and the pound’s continued decline.

The Chancellor’s notable absence in recent days has fuelled speculation, with official communications limited to Treasury statements and a single appearance by her deputy, Darren Jones. Despite declining economic growth and turmoil in UK bonds and the pound, the government has reiterated its commitment to maintaining its current spending and taxation plans.

The economic backdrop remains challenging. Borrowing costs have soared, and the pound has weakened following evidence that the economy has stagnated under Labour leadership. Reeves had pledged to stimulate growth to support significant public spending increases in the coming years. However, without economic expansion, the government may find it increasingly difficult to manage its mounting debt.

Investors are keen to learn whether the Chancellor has been contemplating new strategies to address rising borrowing costs and will introduce policies to restore confidence in the UK economy. In the near term, the path of least resistance for sterling appears to be downward.

Investors Reassess Federal Reserve Policy Outlook Amid Rising Dollar and Market Tensions

Investors have adjusted their expectations for Federal Reserve policy in the coming year. Fed funds futures now show a significantly higher probability that the Fed will pause its easing cycle at upcoming meetings.

This recalibration reflects a growing consensus that current economic conditions may not justify further rate cuts in the near term. As 2025 begins, markets are pricing in only a single rate cut for the year. This sentiment has bolstered the US dollar, which has reached its highest level since November 2022. The trend forms part of a mini-cycle that began in October, marked by the bottoming of yields, stocks, and the dollar.

Despite these developments, equities are facing headwinds as yields and the dollar continue to climb. The S&P 500 has dropped about 5% since its mid-December peak, while the VIX has risen from approximately 14 to 19 points during the same period.

Market attention now turns to key US economic indicators this week, including the NFIB Business Optimism Index and the Producer Price Index (PPI). The PPI, expected to increase from 3% to 3.4%, could reinforce the argument for the Federal Reserve to maintain its current rate stance through the first half of 2025.

Germany's Dual Dependency Dilemma: Balancing Between the US and China

Germany has long thrived as a sovereign force in the global market, driven by its export-led economy. However, beneath this success lies a complex web of dependencies that influence the nation’s strategic decisions. Chief among these is Germany's reliance on two major economic powers: the United States and China. Navigating this dual dependency presents a significant challenge as Germany seeks to balance the interests of these influential partners.

As global geopolitical and economic dynamics evolve, Germany faces the task of leveraging its trade relationships with both the US and China while diversifying its partnerships to reduce vulnerabilities. This "dual dependency dilemma" is further complicated by a lack of consensus within the German government and public, making the path forward increasingly fraught.

Market sentiment reflects these challenges. The euro recently dipped below the $1.02 mark against the dollar, signalling waning optimism. Meanwhile, implied volatility for the euro on the three-month tenor surged to 9.4%, the highest level since March 2023, underscoring heightened uncertainty in the economic outlook.

US Jobs Surge Shakes Markets as Dollar Climbs and Yields Soar

A robust US jobs report sent ripples through financial markets on Friday, propelling the US dollar to its highest level since November 2022 and triggering a surge in yields across the curve. The report revealed an above-consensus increase of 256k jobs, accompanied by a drop in the unemployment rate to 4.1%, with only minor downward revisions to the prior two months. While the labour market strength was anticipated, the scale of the surge exceeded expectations, as forecasts had predicted a 190k increase (compared to a 160k consensus).

This development signals to the Federal Reserve (Fed) that rate cuts are unlikely in the first half of the year. Investors have adjusted their expectations, now anticipating policy easing to begin in October. The resilience of the US labour market has been remarkable, particularly given its continued strength following the 2022 yield curve inversion—a rare phenomenon. This anomaly may partly explain the sharp rise in yields, despite the Fed initiating its easing cycle.

British Pound Slides Amid Stagflation Worries and Rising Yields

The British pound extended its decline on Monday, with GBP/USD falling below $1.22 to its lowest level since November 2023, while GBP/EUR dropped below €1.19 for the first time in over two months. Mounting concerns about stagflation in the UK are weighing on the currency, as inflation—particularly in the services sector—remains stubbornly high amid signs of economic weakness.

The UK’s two-year inflation breakeven rate has surged by 70 basis points since the autumn 2023 budget, which unveiled ambitious borrowing and spending plans. While UK gilt yields have moved in tandem with US Treasury yields, the pound has weakened as the US dollar strengthened. This reflects the mounting pressure on the UK government as gilt yields climb higher. Over the weekend, UK Chancellor Rachel Reeves reaffirmed that the fiscal rules laid out in October’s budget are non-negotiable, encouraging traders to test key support levels for sterling.

This week, markets will closely watch the UK’s December inflation data, with Wednesday’s report expected to show headline consumer prices rising 2.6%, matching the previous figure. Additionally, GDP and retail sales data will be scrutinised for signs of a recovery in consumer spending, which could provide some much-needed relief for the pound.

EUR/USD Slides as USD Strength and European Risks Weigh on the Euro

EUR/USD continues its downward trend, trading in negative territory for a fifth straight day and approaching the $1.02 level during the early European session. The pair’s decline is largely driven by broad-based US dollar strength following a robust US jobs report, while weak domestic factors—both cyclical and political—add further pressure on the euro.

Similar to the UK, Europe faces stagflation risks. December inflation data showed an uptick, mainly due to fuel price base effects, alongside resilient services sector numbers. While this could suggest caution for the European Central Bank in easing policy, the Eurozone's bleak growth outlook complicates the situation. Challenges include China’s economic struggles and potential trade tensions with the US, creating a mix of stagnating growth and persistent inflationary pressures that undermine the euro.

Political uncertainty within Europe further exacerbates the euro’s struggles, highlighting the need for fiscal interventions, particularly in Germany, to rejuvenate the sluggish economy.

With limited high-impact European data scheduled for the week, EUR/USD is likely to remain influenced by external factors. The continued economic outperformance of the US does not bode well for the euro in the near term.

UK Markets in Turmoil: A Rocky Start to 2025 for the British Pound and Gilts

The first full week of 2025 has been turbulent for UK assets. Gilts faced a sell-off, driving yields to their highest levels in over a decade, while the British pound plummeted over 1%, reaching its lowest point in more than a year against the US dollar. This decoupling between GBP and yields has sparked comparisons to the 2022 Truss budget chaos. However, this time the instability stems less from shock policy moves and more from surging debt costs, limited fiscal flexibility, and a challenging global interest rate environment.

The Labour government faces mounting pressure to manage the deficit as borrowing costs rise. The chancellor’s £10 billion fiscal headroom is likely depleted, setting the stage for difficult decisions in the spring Budget. Despite having lower debt levels than nations like the US, France, Italy, and Japan, the UK’s persistent inflation and sluggish economic growth are fuelling stagflation fears, complicating the Bank of England’s (BoE) policy options.

Although the gilt market has shown some stabilization, aided by overnight index swaps pricing in an additional 10 basis points of easing by year-end, the pound remains weak, trading below $1.23. Options market activity highlights increased demand for protection against further GBP weakness over the next month, quarter, and year, positioning GBP as the most vulnerable G10 currency for H1 2025. Volatility expectations are also climbing, with EUR/GBP one-month implied volatility hitting its third-highest close since July 2023 and GBP/USD volatility reaching a near two-year peak.

The pound is also under threat from speculative positioning and the incoming Trump administration’s policy agenda. GBP was the only long position held against the dollar by speculators at the year’s start, leaving it susceptible to sharp unwinds that could accelerate its decline. While the UK is less exposed to tariff risks compared to other regions, it remains vulnerable through the risk sentiment channel. Could GBP/USD hit $1.20 soon? While not inevitable, the rapid decline this week suggests a short-term pullback is likely before further downside risks materialise.

Dollar Rallies Ahead of Key Jobs Report as Market Uncertainty Persists

US markets remained idle yesterday, closed to honour the passing of former President Jimmy Carter. However, investors showed no hesitation in buying the dollar ahead of today’s critical labour market report. The Greenback extended its rally for a third straight day, poised for yet another positive week. If the jobs data avoids a downside surprise, this would mark the 14th weekly gain in the last 15 weeks for the US Dollar Index.

Investors continue to grapple with uncertainty surrounding the future policy direction of major central banks. Ahead of the nonfarm payrolls (NFP) release, Philadelphia Fed President Patrick Harper emphasized that the timing of rate cuts will hinge on economic conditions. This data-dependent stance has heightened investor focus on macroeconomic releases to gauge monetary policy trends. Supporting this cautious approach, two other Fed officials noted that recent inflation surprises justify a slower pace of easing, with markets now pricing in only one rate cut for 2025.

For the Fed, only a significant deviation from consensus in today’s NFP print is likely to shift the policy outlook. December hiring is expected to show a slowdown (165k) compared to November’s 227k, while the unemployment rate is forecast to remain steady at 4.3% and average hourly earnings to cool. This data is likely to support the current pricing of a single 2025 rate cut.

Investors await the results, the dollar's strength underscores its resilience amidst persistent market uncertainty and its role as a safe haven in the evolving monetary policy landscape.

The Euro Struggles Amid Rising Global Bond Yields

The euro faces continued pressure from the global surge in bond yields, even as market risk sentiment remains relatively stable. The currency declined against the US dollar for another session, marking the likelihood of five consecutive weekly losses. If the EUR/USD pair closes below the $1.03 mark today, it would be the first occurrence since late 2021.

Robust US employment figures and persistent inflation have fuelled concerns about the strength of the US economy. This has raised speculation that the Federal Reserve might hike interest rates again, further driving up bond yields. Although inflation has cooled somewhat, it remains above the Fed’s target, intensifying fears of prolonged higher interest rates. Additionally, expectations surrounding Donald Trump's anticipated budget expansion have contributed to higher US bond yields and term premia, with ripple effects on global markets—a challenging environment for the euro.

In the Eurozone, domestic data presents a mixed economic outlook. Disappointing German factory orders and retail sales contrasted with stronger-than-expected export growth and industrial production. While external factors primarily weigh on the euro, these domestic developments do little to inspire confidence in the region's growth prospects.

Tumultuous Day for the British Pound and UK Markets

The British pound and UK equity benchmarks experienced sharp declines yesterday, with bond prices tumbling and yields surging. The 10-year gilt yields reached their highest level since the 2008 financial crisis, while 30-year yields climbed to levels not seen since 1998.

The pound fell by over 1%, with GBP/USD hitting its lowest level in more than a year. Breaking through its Bollinger band and last year’s lows, the pair is now approaching the October 2023 low of $1.2037. Sterling faced significant volatility across G10 currencies, with daily declines exceeding two standard deviations compared to the average performances over the past five years. Even GBP/EUR, which had remained stable above €1.20 for weeks, has dropped closer to €1.19.

This turmoil was largely triggered by weak demand in recent UK government debt auctions. The resulting surge in long-term borrowing costs pushed bond yields to multi-decade highs. While higher yields could theoretically support the pound, persistent economic concerns—characterized by weak growth, sticky inflation, and fears of stagflation—outweighed any potential benefits.

These events signal a broader reassessment of the UK’s economic prospects under the Labour government. Optimism about political stability has given way to worries over rising taxes, public spending, stagnating growth, and inflation. The market's reaction mirrored the turmoil of the 2022 Liz Truss budget, although the current situation is less severe. However, the UK’s persistent current and capital account deficits leave the pound exposed to foreign investor sentiment.

Adding to the pressure, the pound seems disconnected from the expected monetary policy path. Divergences between GBP/USD and UK-US yield spreads highlight this growing gap. The Bank of England’s policy trajectory compounds the challenge; while markets expect minimal rate cuts, stagflation fears have muted any potential boost to sterling. Conversely, stronger signals of rate cuts could weigh further on the currency.

For the pound to stage a recovery, a combination of stronger economic data and improved confidence in fiscal policy will be essential. Until then, sterling remains vulnerable to both domestic and international pressures.

US Dollar Gains Momentum Amid Economic Optimism and Fed Hawkishness

The US dollar has regained strength, buoyed by encouraging economic data and hawkish minutes from the Federal Reserve's December meeting. These developments have validated the Fed’s pivot to a more aggressive stance on rate cuts, driving the dollar's rebound against major currencies. Long-term Treasury yields are also nearing 5%, reflecting this optimism. However, much of the positive sentiment appears to be already factored into the dollar and bond markets.

Attention now shifts to Friday’s monthly jobs report, a key data release ahead of the Fed’s next monetary policy decision. This report will provide the final labour market update before the Fed enters its pre-meeting blackout period. Expectations are for US payrolls to have increased by 163,000, with the unemployment rate remaining steady at 4.2% and average hourly earnings rising 0.3% month-over-month. The chart below illustrates how closely inflation and labour market data influence market expectations for the Fed's policy trajectory. The Fed funds rate pricing has closely tracked surprises in inflation and employment metrics, highlighting the ongoing dominance of the Fed’s dual mandate in shaping market sentiment.

October marked a turning point for this proxy indicator of the Fed’s mandate and the dollar's performance. While the index has plateaued since November, the dollar's rally has continued, driven by two key factors: the "Trump trade" and growing political risks outside the US. Together, these dynamics have reinforced the Greenback’s resilience in the face of evolving market conditions.

EUR/USD Struggles Amid Diverging Economic Trends

The EUR/USD pair experienced a turbulent session yesterday and is trading near $1.03 this morning. The US dollar continues to gain strength this week, supported by strong economic data, including robust employment numbers and improved consumer confidence. These indicators have reinforced expectations of a hawkish Federal Reserve, boosting the greenback.

In contrast, the Euro faces headwinds from weak economic data in the Eurozone. German factory orders unexpectedly declined in November, signaling deeper economic challenges. Additionally, German retail sales contracted during the same period, raising concerns about the health of the Eurozone’s largest economy. These disappointing figures, combined with rising energy prices and the ongoing energy crisis, have weighed heavily on investor sentiment toward the Euro.

The outlook for EUR/USD remains uncertain. If US economic data continues to surprise on the upside and the Fed maintains its hawkish stance, the Euro may face further pressure. However, signs of weakness in the US economy or a shift toward a more dovish Fed could offer some relief to the common currency.