Dollar retreats over Trump tariff speculation

Important calendar events

• JPY: Monetary Base
• GBP: BRC Retail Sales Monitor, Halifax HPI, Construction PMI
• EUR: Italian Monthly Unemployment Rate, CPI, and Core CPI Flash Estimate
• USD: Trade Balance, ISM Services PMI, JOLTS Job Openings

USD

The dollar dipped on Monday and the dollar index retreated from a two-year high, dropping from 109.0 to 108.3. US treasury yields increased on reduced Fed rate cut expectations, with the US 10-year bond yielding 4.63%. 

The dollar has been gaining strength as the start of President-elect Donald Trump’s presidency is drawing near on expectations that Trump’s fiscal policies and trade tariffs will boost economic growth. On Monday, however, reports that Trump’s tariffs will be more moderate than previously anticipated, drove the dollar down. According to the Washington Post, Trump is considering imposing international tariffs only related to sectors deemed critical to national or economic security. Trump, however, later denied these rumors, stating that the claims by the Washington Post were completely false. 

In addition, US Services PMI and Factory orders released on Monday fell short of expectations, driving oil prices down. The Final Services PMI for December came in at 56.8, below expectations of 58.5. A print above 50.0 indicates that the US Services sector continues to expand, but the rate of expansion is slowing down. US factory orders dropped by 0.4% in November against expectations of a 0.3% drop, but October’s print was revised upward to reflect 0.5% growth. 

The US Federal Reserve cut interest rates by 25 basis points at its latest meeting to a target range of 4.25% to 4.50%. Fed Chair Jerome Powell delivered a hawkish message after the policy meeting, emphasizing the need to be cautious about further rate cuts. Powell stated that the Fed’s approach will remain data-driven and hinted that future rate cuts will be slower, as inflation in the US remains above the central bank’s 2% target. 

The Fed’s latest dot plot indicated that only two rate cuts will take place in 2025, down from four projected in September. In quantitative terms, policymakers expect to deliver a total of 50 basis points of rate cuts in 2025, which will bring the central bank’s interest rate to 3.9% by the end of 2025, which is significantly higher than the 3.4% estimated in September. 

US inflation is proving to be sticky despite the Federal Reserve’s efforts to bring it down to its 2.0% target. US Headline inflation rose to 2.7% year-on-year in November from 2.6% in October. Monthly inflation rose by 0.3% in November, the same as in October, which was in line with expectations. Core CPI, which excludes food and energy, rose by 0.3% in November. 

Final GDP data for the third quarter of the year showed that the US economy expanded by 3.1% in the third quarter of 2024, up from 2.8% estimated earlier. In addition, the US economy expanded by 3.0% in the second quarter of the year and by 1.4% in the first quarter of the year. 

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EUR 

EUR/USD rose from 1.030 to 1.039 on Monday, as the dollar lost its bullish momentum. If the EUR/USD pair declines, it may find support at 1.022, while resistance may be encountered near 1.045.

German Preliminary CPI data released on Monday came in above expectations, indicating that inflation in the Eurozone may be flaring up again. German CPI rose to 2.6% year-on-year in December from 2.2% in November, exceeding market expectations of 2.4%. Every month, German inflation rose by 0.4% after declining by 0.2% in November. The Eurozone Sentix Investor Confidence Index released on Monday came in at -17.7 in January falling below December’s print of -17.5, indicating that investors’ confidence is declining.

The ECB lowered its benchmark interest rate by 25 basis points in December, bringing its main refinancing rate to 3.15%. This was the fourth rate cut for the ECB this year, which started its easing cycle in June and has already lowered interest rates by a total of 100 bps. More importantly, ECB President Christine Lagarde hinted at further easing in the coming months as Eurozone inflation nears the central bank’s target while the economy remains weak.

Lagarde’s press conference after the policy meeting was dovish, raising expectations of further rate cuts. The central bank is currently expected to cut interest rates up to five more times next year, to a total of 125bps, until neutral policy settings are reached. Expectations that the ECB will return to a more normalized policy setting sooner than the Fed, are putting pressure on the EUR/USD rate. 

Eurozone inflation remains above the ECB’s 2% target and may prevent the ECB from cutting interest rates in December. Eurozone inflation rose to 2.3% year-on-year in November from 2.0% in October, which was in line with expectations. Core CPI, which excludes food and energy, remained steady at 2.7% in November, against expectations of a 2.8% print. 

Flash GDP data showed that the Eurozone economy expanded by 0.4% in Q3 of 2024, rising from 0.2% in Q2. The Eurozone economy also expanded by 0.3% in the first quarter of 2024. The economic outlook of the EU remains fragile as prolonged tightening has brought the Euro area economy to the brink of recession.

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GBP 

GBP/USD rallied on Monday, rising from 1.241 to 1.251 as the dollar dipped. If the GBP/USD rate goes up, it may encounter resistance at 1.261, while support may be found near 1.235.  

UK Services PMI data released on Monday revealed a drop in the PMI index to 51.1 in December from 51.4 in November. The British Services sector continues to expand, as evidenced by a print above the threshold of 50.0, but it is expanding at a reduced pace. 

The BOE kept interest rates steady at its latest policy meeting, having cut interest rates twice already this year. MPC members voted 6-3 to keep rates on hold, with three members in favor of cutting interest rates. Last week’s MPC voting shows a shift to a hawkish direction, as policymakers had voted with a strong majority of 8-1 to cut rates to 4.75% in October. 

Bank of England Governor Andrew Bailey reiterated his former message that the central bank needs to adopt a gradual approach to future rate cuts. Bailey also stressed that the BOE’s policy outlook will remain data-driven and refused to commit to a timeline or magnitude of future rate cuts.  

Headline inflation in the UK rose to 2.6% year-on-year in November from 2.3% in October. Core annual inflation, which excludes food and energy, climbed to 3.5% in November from 3.2% in October against 3.6% anticipated. 

Final GDP data for the third quarter of the year showed that the British economy is stagnating. Earlier forecasts indicated slight economic growth by 0.1% in the third quarter of 2024, but the British economy is being stifled by high interest rates and cannot expand. 

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JPY

USD/JPY exhibited high volatility on Monday, plummeting from 157.8 to 156.5 in early trading, but pared losses later in the day. If the USD/JPY pair declines, it may find support at 155.9. If the pair climbs, it may find resistance at 158.0. 

The BOJ maintained its current monetary policy guidelines steady and its interest rate at 0.25% at its latest policy meeting. BOJ policymakers decided to keep rates unchanged in an 8-1 vote split, as one member voted in favor of a 25-bps hike. BOJ Governor Kazuo Ueda stated that Japan’s economic and inflationary outlook remains uncertain and stressed that the central bank’s policy will remain data-driven. In a speech on Monday, Ueda reaffirmed the BOJ’s commitment to continue raising interest rates if Japan’s economy continues to improve. Ueda cautioned, however, that the timeline of the rate hike will depend on economic and inflationary conditions. 

Odds of a BOJ rate hike in December are still below 50% but markets are pricing in a total of 50 basis points worth of rate cuts by the end of March.

Inflation in Japan is on the rise, raising the odds of future rate hikes and providing support for the Yen. The headline Tokyo CPI inflation rose to 3.0% annually in December, up from 2.6% in November. Headline inflation in Japan rose by 2.7% year-on-year in November from 2.3% in October against expectations of a 2.6% print. In addition, BOJ Core CPI rose to 1.7% year-on-year in November from 1.5% in October against expectations of 1.5%. 

Final GDP data for the third quarter of the year showed that Japan’s economy expanded by 0.3%, exceeding initial estimates of 0.2%, but down from 0.7% in the second quarter. The Japanese economy is expanding, after shrinking by 0.5% in the first quarter of the year. 

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Written by:
Myrsini Giannouli

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