Headline inflation in the United States exceeded expectations slightly, registering at 3.4%, thereby diminishing the likelihood of an early interest rate reduction by the Federal Reserve and driving yields upwards.

Market sentiment hinges significantly on the outlook for interest rate differentials, with ongoing speculation regarding the timing and extent of potential rate cuts continuing to propel market momentum.

Currently, the Bank of England is priced at a 75% probability of implementing a 0.25% rate cut in June. However, market forecasts of a total 1.25% reduction throughout the year may appear overly aggressive, given the persistent elevation of inflation and wage increases. The Bank remains committed to a 'higher for longer' stance and is likely to exercise caution in implementing early cuts.

The U.S. central bank is anticipated to lead the way in initiating a cycle of rate cuts, possibly as early as March, with forecasts projecting up to 1.40% in cuts for the year. After a significant decline in inflation throughout 2023, the focus has shifted towards supporting the economy and achieving a 'soft landing.'

Amidst the weakest economic fundamentals and a bleak growth outlook for the Eurozone, the European Central Bank may find itself compelled to be the most assertive in implementing rate cuts.

Persisting geopolitical tensions, particularly the risk of the Middle East conflict spreading, continue to be a genuine concern at the forefront of investors' minds.

The start of the year on exchanges has been cautious, marked by unprecedented uncertainty leading to a lack of clear conviction. The upcoming release of key UK data next week is expected to heighten volatility in the markets.

Following a decline in the previous period, the British economy experienced a rebound in November, dispelling concerns of a potential recession that arose with the October dip in economic activity. The recently released GDP report reveals a welcome monthly growth of 0.3%, aligning with the ongoing recovery observed in the purchasing manager index. This positive development is likely to be well-received by British policymakers.

In 2023, the 3-month average growth rate slipped into negative territory for the first time, following two consecutive months of stagnation. Industrial production fell by 0.1%, and manufacturing output increased less than anticipated, reaching 1.3% compared to the expected 1.7%.

Initially responding negatively to the report, the pound is currently trading slightly lower. The decline in GBP/USD and EUR/USD during the Asian session cannot be solely attributed to the GDP print. Global concerns are mounting, with the US and UK launching strikes against Houthi rebels in Yemen, prompting retaliatory actions from the Iran-backed militia. Additionally, China's economic performance continues to fall short of expectations, potentially impacting market sentiment and the British pound. Chinese exports experienced a 4.6% year-on-year decline, marking the first negative growth rate since 2016. Producer price inflation in China remained negative throughout 2023, constituting its longest streak of declines since 2009.

Despite reaching around $1.2785 in the Asian session, GBP/USD has trended lower to $1.2760. While the currency pair remains positive for the day and is poised for its seventh daily rise in eight days, sustained upward momentum would require a break above $1.28. Notably, the pound stands out as the top-performing G10 currency for the week, exhibiting strength against all other currencies in this category. The macroeconomic factors continue to drive the sterling's robust performance.

The Euro experienced slight gains against the US dollar as investors processed remarks from several hawks within the European Central Bank (ECB) while eagerly anticipating the release of a crucial US Consumer Price Index (CPI) report. This data could provide insights into when the Federal Reserve might consider implementing interest rate cuts later this year.

Luis de Guindos, the Vice President of the ECB, delivered a somber warning to the markets, suggesting that the eurozone economy appears poised for another downturn in Q4 2023. Despite a recent uptick in inflation, he highlighted the possibility of its persistence in the coming months. Soft indicators indicated economic contraction in December, with risks to near-term growth leaning towards the downside. The eurozone economy remained stagnant for much of 2023, contracting by 0.1% in Q3. A modest activity increase is anticipated in the current year, with the World Bank forecasting 0.7% growth for 2024, up from 0.4% in 2023.

The ECB faces a challenging dilemma in its upcoming January meeting, grappling with the decision of when to commence rate cuts amid a fragile economic outlook and inflation above the 2% target. Isabel Schnabel emphasized the central bank's dependence on data, stressing the need for additional evidence before contemplating rate cuts. Consequently, market expectations for policy easing were downgraded, with a rate cut in the first quarter of 2024 no longer factored in.

Lack of sustained bullish momentum caused EUR/USD to fluctuate within a narrow range of €1.0921 to €1.0981 leading up to this week's pivotal risk event. A downside surprise in the US CPI could prompt investors to elevate expectations for a Fed rate cut. In such a scenario, EUR/USD might potentially rally beyond the €1.1000 level, aiming for the December highs around €1.1100.

The US dollar saw a consecutive second-day uptick, primarily driven by gains against the euro, pound, and yen. Investors are anticipating the crucial US Consumer Price Index (CPI) report scheduled for tomorrow, a determining factor for the Federal Reserve's stance in the upcoming January meeting. Economists predict a slight uptick in December's inflation from 3.1% to 3.2%. Nevertheless, core inflation is expected to continue its descent, cooling by 20 basis points to 3.8% by the end of last year.

Market expectations ahead of the event include pricing in six rate cuts, each worth 25 basis points, throughout 2024, with March as the starting point for the easing cycle. The recent NFIB survey, released yesterday, had minimal impact on altering this perspective. Small business optimism in the US rose to its highest level in five months in December, climbing from 90.6 to 91.9. Price and compensation expectations remained relatively stable, pointing towards an increase in inflation and wage growth in the second quarter of the current year.

US Treasury yields are experiencing a decline across the curve for the week. Equities have successfully recovered from their early-year losses last week, with the S&P500 and Nasdaq gaining 1.5% and 2.2%, respectively. This week presents an intriguing combination of falling yields, advancing stocks, and a strengthened US dollar. GBP/USD is maintaining a holding pattern and continues to struggle to sustain its position above $1.27. Despite seven consecutive weeks of testing this level, the currency pair has yet to decisively break out.