C8 Currency Compass – USD Correction – January 2025
FX Market and Strategy
The USD has made a strong start to the year, driven by a robust January US employment report, as well as expectations for rate cuts outside the US. Incoming President Trump has been relatively quiet this month, though that is likely to end after his Monday 20th inauguration. The key FX driver remains the US import tariff question, though we note that there have been no further developments on that front.
Interestingly, our FX models for USD against EUR, GBP, AUD, NZD and NOK, which were largely USD positive last year, reversed in January. In particular, our reversion models are suggesting some strength in these currencies against USD in the near term. Nevertheless, the continued outperformance of the US economy, alongside sluggish growth in Europe, suggests that any USD reversal will not be sustained.
GBP may prove an exception to this. Whilst it is as oversold as the EUR, political missteps will generate renewed inflationary pressures in the UK with long-term bond yields back to levels last seen in 1999 (see chart below from Bianco Research). Importantly, many of the measures in Labour’s first budget only start to impact in the first half of 2025, so we see further upside for EURGBP.
Currency Focus: Rising Bond Yields Equals Rising FX Volatility
It is not just the UK that has an issue with rising bond yields, though, as discussed overleaf, the issue in the UK has been exacerbated by the lack of confidence in the new government. The first chart below shows that 10-year bonds yields have risen in all G10 countries, with the exception of Switzerland, since the US easing cycle started in September. Official interest rates have fallen in most of the countries over this period, yet the steeper yield curve suggests that, at last, fiscal policy matters to markets. Over the 10 years of QE, there was little concern around demand for government debt, which was all but guaranteed by central bank purchases.
This is no longer the case, a key component to our view that FX volatility will increase in 2025. To illustrate how unusual the recent curve steepening is, the bottom right chart shows how 10-year bonds have performed during all US easing cycles since 1967. The only case worse than this latest move was in 1981, when US inflation averaged over 10%! In some respects, the US is less vulnerable than others given they are the biggest beneficiary of the tech revolution. However, fiscal expansion is no longer an option to offset any economic slowdown, forcing hard choices which are already causing political problems in Europe.
Key Event Dates
Mon 20 Jan US Pres Inauguration Return of President Trump
Fri 24 Jan Japan BoJ Meeting Expect 25bp rate hike to o.5% + focus on press conference
Weds 29 Jan US FOMC Meeting Expect unchanged in line with market expectations
Weds 29 Jan Canada BoC Meeting Expect 25bp rate cut to 3%
Thurs 30 Jan EUR ECB Meeting Expect 25bp rate cut to 2.75%
Mon 3 Feb US ISM Manufacturing Expected to keep rising in the first half though may be impacted in Jan by California fires
Weds 5 Feb US ISM Non-Man Expected to keep rising in the first half though may be impacted in Jan by California fires
Thurs 6 Feb UK BoE Meeting Expect 25bp rate cut to 4.50%
Friday 7 Feb US Non-farm Payroll Closely watched after strong Jan figures