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Conflicting tariff talk moves markets

Déjà vu. Euro pounces on tariff news. Retail sales help pound’s rebound.

Written by Convera’s Market Insights team

Déjà vu

George Vessey – FX Strategist

It looks like Trump 2.0 might be similar to Trump 1.0 – that is, in terms of how sensitive markets will be to press leaks and social media posts by the US President-elect. The dollar dropped over 1% against a basket of major currencies in the wake of a Washington Post report that aides to Donald Trump are considering tariffs on all countries, but only on sectors seen as critical to national or economic security. The dollar then sharply pared some of its losses after Trump dismissed the report in a post on Truth Social.

The dollar’s reaction to the conflicting news highlights how much of the currency’s strength is based on anticipation of broad, and early, tariffs. It also implies that the dollar’s recent strength is more dependent on fiscal rather than monetary policy, although the latter should still be considered a strong positive driver. The dollar index clipped a fresh two-year high last week after ending 2024 at its highest annual close in two decades. The resilient US economy, the potential for higher inflation from strong consumer spending, compounded by tariffs, plus the rising expectations of a slower pace of rate cuts from the Federal Reserve remain bullish drivers for the buck in 2025. We are wary the dollar’s extended rally in December stretched a bit too far though when compared to our positive dollar factor index.

Still, it’s important to note that FX volatility is expected to pick up this year, not least because of the uncertainty surrounding Trump’s tariff plans and fiscal policy. In the very short-term though, market participants will also be keeping an eye on macro data, with JOLTS job openings data and the ISM services index for December published today and the non-farm payrolls report due on Friday.

Chart of US dollar index and positive push factors

Euro pounces on tariff news

George Vessey – FX Strategist

The euro catapulted over 1% higher versus the US dollar, from near 2-year lows, after the tariff news from the US, but has trimmed gains slightly to trade near $1.04. The rise in German short-term yields, after the nation’s headline inflation number came in hotter than forecast across the board, also supported the common currency more broadly, though GBP/EUR remains afloat €1.20.

German headline inflation came in at 2.6% y/y, up from 2.2% in November and 1.6% in September. The re-acceleration in German inflation was mainly the result of less favourable energy base effects. However, although bund yields are on the rise and European Central Bank (ECB) easing bets are being pared somewhat, economic sentiment remains weak and the growth outlook feeble. Thus, stagflation concerns are back in the spotlight in the short term. Might this deter the ECB from cutting rates in January? It’s unlikely, and markets agree, given a 25bps cut remains fully priced in, and three additional cuts are expected through 2025.

As for the euro – diverging policy expectations between the Fed and ECB remain a major hindrance via the widening in the short-dated swap rate differential. True, we may be near peak European pessimism and therefore a bottom for the euro. But the domestic context, both cyclical and political, remains convincingly euro-negative, and the rise in gas prices, and threat of US tariffs only add to the bearish factors one should consider before jumping on the EUR recovery wagon.

Chart of EURUSD and swap differential

Retail sales help pound’s rebound

George Vessey – FX Strategist

Just like the euro, the British pound staged a strong rebound versus the US dollar on Monday and has held onto those gains so far today after some upbeat UK retail sales data. GBP/USD is back above $1.25 having slipped under $1.24 last week, almost two standard deviations lower than last year’s average rate of $1.28.

The pound seems to be trading more in parallel with the euro – weakening last week to fresh cycle lows, before rebounding this week over a cent. Historically the two currencies have exhibited a high correlation, explained by the interconnective relationship between the euro area and UK economies. That correlation has increased in recent days, perhaps due to concerns about looming tariffs and rising gas prices, especially the latter due to the UK’s energy dependency meaning its terms of trade will be hit negatively. Nevertheless, recent price action also highlights how sensitive other major currencies, like GBP, are to news from the US, especially regarding the uncertain tariff narrative.

Domestically speaking, the compellingly UK bullish 2024 cyclical case is under pressure from the Oct. 30 budget, with business confidence at a two-year low. There is a risk that unlike 2024, the economic news flow surprises to the downside in 2025. However, that wasn’t to be the case in retail sales data from the British Retail Consortium this morning. Retail sales in the UK surged 3.1% in December compared to the previous month’s 3.4% decline, and far exceeding market expectations of a 0.2% drop. 10-year UK yields (4.61%) are a whisker away from printing their highest level since 2008. The spread between UK and German yields remains at multi decade highs, helping to keep GBP/EUR elevated above €1.20.

Chart of UK-German yield spread

Dollar dumped, euro and pound jump

Table: 7-day currency trends and trading ranges

Table of FX rates

Key global risk events

Calendar: January 6-10

Table of risk events

All times are in GMT

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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.

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