Written by the Market Insights Team
Yields hit yearly lows
Boris Kovacevic – Global Macro Strategist
US bond yields across the curve have dropped to their lowest level of the year, despite inflation expectations—both survey-based and market-based—continuing to trend higher.
Concerns over the US budget deficit and rising debt levels have contributed to an increase in the term premium, which has pushed bond yields higher. However, yesterday’s announcement that the Treasury would maintain the size of upcoming bond issuance was welcomed by bond bulls.
Additionally, demand for safe-haven assets surged following a weaker-than-expected ISM services figure, which showed a decline from 54 to 52.8. While the data may raise concerns, we believe it’s important not to over-interpret it. Notably, the employment sub-index rose at the fastest pace since September 2023, aligning with the strong ADP private payrolls report earlier in the session. This strengthens the positive outlook for the upcoming nonfarm payrolls report on Friday.
Meanwhile, the US dollar continued to lose ground from its tariff-related gains as trade premiums decreased. After falling against all G10 currencies in yesterday’s session, investors are now focused on today’s BoE decision, three upcoming Fed speeches, and the release of initial jobless claims.
When tariffs backfire
Kevin Ford – FX & Macro Strategist
In a paper published by Jeanne and Son in 2020, they explain how tariffs are partially offset by currency appreciation in the country that imposes tariffs or by depreciation in the country that receives the tariff. The timing might be ironic, but the trade numbers released yesterday from the U.S. and Canada might confirm the theory.
The U.S. trade deficit in December expanded significantly to -$98.4 billion from -$78.9 billion in November, marking the largest gap since March 2022. The boost in import aligns with the robustness of the U.S. consumer. However, a strong U.S. dollar weighed on export growth. Trump’s desire for a weaker dollar aims to close the deficit, but tariff threats may not be aiding his cause. As the dollar strengthened in December, driven by Trump’s tariff remarks, the trade deficit widened. Maybe this will catch the administration’s attention?
In contrast, a weaker Loonie helped Canada achieve a surplus in December. The Canadian trade balance turned positive with a +$710 million surplus, compared to a -$1 billion deficit the previous month. Notably, this figure excludes services, where Canada typically runs a deficit, particularly with the U.S. For reference, the overall goods and services trade balance in November was -$600 million, according to Stats Canada.
Other relevant macro data was published yesterday. According to the ADP employment report, 183,000 jobs were created in January in the U.S, surpassing the anticipated 150,000. However, the ADP Employment Report rarely predicts the NFP report, which is the big-ticket item this Friday morning. On the other hand, the U.S. ISM Services PMI for January stood at a robust 54.0, though the Prices Paid index was elevated at 64.4, heightening inflationary pressure concerns.
The U.S. dollar declined for the third consecutive day as global currencies rebounded from Monday’s lows. The DXY index inched closer to the 107-support level. Additionally, the USDCAD fell to 1.4270 from Monday’s high of 1.4793, nearing the January low of 1.4261.
BoE rate cut expected, mind vote split
George Vessey – Lead FX & Macro Strategist
The dust has settled somewhat over the tariff-related tumult which had dragged GBP/USD towards $1.22 at the start of the week. Now the pair has pierced through its 20-day and 50-day moving averages, looking to hold above the $1.25 threshold to build on recent gains. The Bank of England’s (BoE) monetary policy meeting today is a key risk event for the pound, with eyes on the vote split and tone of the accompanying communication.
The BoE’s Monetary Policy Committee (MPC) has been following a ‘cut-hold’ tempo since the rate-cutting cycle kicked off last summer. We see another 25bp cut today as almost a certainty and given financial markets do too, the pound is more at risk from deviations in the vote split. We think Catherine Mann is likely to be the sole dissenter of such a move, but if she votes for a cut as well, this would be a dovish surprise, raising bets of another cut in March, and hurting the pound. We also think the BoE will likely revise up its near-term inflation forecast due to higher energy and oil prices, and a weaker pound. But higher inflation and market interest rate expectations will lead the MPC to cut its growth forecast, with its 2025 projection likely to drop below 1%.
The UK’s macro backdrop suggests the bigger risk is that markets are under-pricing BoE easing. As well as softer economic activity, services inflation, the BoE’s most important price indicator, fell sharply in December. Moreover, the jobs market is shaky with employment in the private sector weakening last year and vacancies well down. Wage growth has proven sticky but survey data points to a gradual cooling this year. In light of this, we think the pound is more vulnerable to the BoE signalling a more aggressive pace of easing.
The pound’s volatility skew shows sentiment still favours the US dollar across tenors, albeit with much lower conviction in the front-end over recent days. We see short-term upside targets at the 100-day moving average located at $1.26. To confirm the recent breakout of the descending trend channel, the pair needs to remain above $1.24, which might prove a challenge if the BoE does surprise on the dovish side. We do note that the correlation between rate differentials and GBP/USD has been far less distinct of late though. Plus, there remains an obvious risk premium around tariffs to bear in mind, which makes for unexpected and exaggerated price swings in the FX the space.
Euro back above $1.04
Boris Kovacevic – Global Macro Strategist
The French government survived a no-confidence vote on Wednesday, paving the way for the passage of its delayed annual budget. While this outcome was largely anticipated and priced in, it remains a positive development. The French risk premium—measured by the spread between German and French bond yields—has declined from its peak of around 90 basis points to 70. Meanwhile, French equities have outperformed both US and broader European markets, posting a year-to-date gain of 7%.
Risk assets may find additional support from the ECB, which is expected to implement rate cuts totaling 87 basis points this year. However, the extent of monetary easing will depend on the implementation of US tariffs and the trajectory of European inflation. Investors have slightly scaled back their rate-cut expectations following comments from ECB Chief Economist Philip Lane, who suggested that inflation could take longer to decline than previously anticipated.
The euro has extended its gains for a third consecutive day—its longest winning streak since late October. EUR/USD will need to break above the 50-day moving average at $1.0420 to sustain its upward momentum toward $1.05.
CAD higher vs. EUR and GBP
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: February 3 -7
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.
