Dollar rallies on renewed tariff threats

Important calendar events

• JPY: Monetary Policy Meeting Minutes, Consumer Confidence
• EUR: German GfK Consumer Climate, Spanish Flash GDP, M3 Money Supply, Private Loans
• USD: Federal Funds Rate, FOMC Statement, FOMC Press Conference

USD

The dollar rallied on Tuesday, and the index rose from 107.3 to 107.9. US treasury yields remained steady ahead of Wednesday’s Fed rate decision, with the US 10-year bond yielding approximately 4.54%. 

At its latest meeting, the US Federal Reserve cut interest rates by 25 basis points 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. 

Markets this week will focus on the Fed’s rate decision on the 29th. The central bank is widely expected to keep interest steady this week and market odds of a rate cut are practically nil. Odds of another rate cut before summer are low and traders will focus on the Fed’s forward guidance to predict the timeline for future rate cuts. 

US President Donald Trump’s speech at the World Economic Forum in Davos last week attracted considerable market attention. Trump commented on the Fed’s interest rate stating that he will demand an immediate cut in interest rates. The Fed’s monetary policy, however, is unlikely to be affected by Trump’s demands, and market odds of future rate cuts remained largely unchanged after Trump’s comments. 

Donald Trump’s Presidential inauguration at the US capitol attracted market attention last week as Trump was sworn in as the 47th president of the United States. The dollar has been volatile as markets await Trump’s policies and trade tariffs. 

Trump has already announced a plan to impose 25% tariffs on imports from Canada and Mexico starting February 1 and he has hinted that his administration is considering universal tariffs on all imports to the US. Rumors of a potential 10% duty on imports from China to the US ignited concerns that other nations may face trade tariffs as well. Trump later went back on his comments on imposing trade tariffs on China, after having a phone conversation with Chinese President Xi Jinping. Over the weekend, Trump threatened Colombia with 50% tariffs on their imports after the country refused to take in deported immigrants from the US. On Monday, however, the Colombian government backed down on accepting deportees from the US, and trade tariffs against the country have been put on hold. 

Trump has been using threats of imposing trade tariffs as a negotiation tool to further his agenda with other countries. On Tuesday, newly appointed US Treasury Secretary Scott Bessent proposed tariffs on all US imports, which would start at 2.5% and could be gradually increased. Trump, however, stated that he wants more aggressive tariffs, saying that he will apply tariffs to chips, pharmaceuticals, steel, and copper. Trump’s comments triggered a risk aversion sentiment and demand for safe-haven assets rose, boosting the dollar. 

US economic activity data released on Tuesday were overall mixed. US Durable Goods Orders contracted 2.2% in December, following a 1.2% decrease reported in November, disappointing market expectations of 0.3% growth. Core Durable Goods Orders, which exclude transportation items, rose by 0.3% in December after dropping by 0.2% in November and against expectations of 0.4% growth. The Richmond Manufacturing Index improved to -4 in January from -10 in December, beating expectations of a -8 reading. On the other hand, the CB Consumer Confidence Index dropped to 104.1 in January from 109.5 in December. Against market expectations of 105.7

Disinflation in the US is progressing, which may affect the Fed’s rate outlook. Headline inflation rose by 2.9% year-on-year in December from 2.7% in November, which was in line with expectations. Monthly inflation rose by 0.4% in December against 0.3% in November, as expected. Core CPI, however, which excludes food and energy, rose by just 0.2% in December following a 0.3% rise in November and against expectations of a 0.3% print. Core CPI rose 3.2% year-on-year in December, below estimates for a 3.3% increase and November’s 3.3% gain. 

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. This coming week, GDP data on Thursday, are expected to show that the US economy expanded by 2.7% in Q4 of 2024.

TRADE USD PAIRS

EUR 

EUR/USD plummeted from 1.049 to 1.042 on Tuesday as the dollar rallied. If the EUR/USD pair declines, it may find support at 1.034, while resistance may be encountered near 1.053.

German IFO Business Climate data on Monday showed that German business sentiment is improving. The German IFO Business Climate index rose to 85.1 in January from 84.7 in December, against expectations of an 84.9 print.

The ECB rate decision this week on the 30th is expected to attract considerable market attention. A 25-bp rate cut this week is fully priced in, which will bring the ECB’s main refinancing rate down to 2.90%. Lagarde, speaking at the World Economic Forum in Davos on Friday, confirmed that the central bank is moving towards normalizing its monetary policy regardless of the threat of trade tariffs from the US. As a January rate cut seems to be a foregone conclusion, traders this week are expected to focus on the ECB’s forward guidance for signs of another rate cut in March. 

The ECB lowered its benchmark interest rate by 25 basis points in December, bringing its main refinancing rate to 3.15%. 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.

The central bank is currently expected to cut interest rates up to five more times in 2025, 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 further. Eurozone inflation rose to 2.4% year-on-year in December from 2.2% in November. Every month, Eurozone inflation rose 0.4% in December after dropping 0.3% in November. Core CPI, which excludes food and energy, remained steady at 2.7% in December. 

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.

TRADE EUR PAIRS

GBP 

GBP/USD dipped from 1.249 to 1.243 on Tuesday as the dollar gained strength. If the GBP/USD rate goes up, it may encounter resistance at 1.260, while support may be found near 1.222.  

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. 

Bank of England Governor Andrew Bailey has stated that the central bank needs to adopt a gradual approach to future rate cuts. Bailey has 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.  

In an interview on Bloomberg on Tuesday, British Prime Minister Keir Starmer stated that he anticipates a turnaround in the UK’s economy. Starmer also appeared optimistic about the UK’s trade relationship with the US. The UK seems to be at an advantage at a time when most other nations are concerned about the imposition of trade tariffs by Trump’s administration. Starmer stressed that the UK’s trading relationship with the US is excellent and that he expects this relationship to improve further in the future. 

The British economy expanded by just 0.1% in November, disappointing expectations of 0.2% growth and following contraction by 0.1% in October. Final GDP data for the third quarter of the year have previously shown 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. 

Price pressures in the UK are easing, raising the odds of a BOE rate cut in February and providing support for the Sterling. Headline inflation in the UK rose to 2.5% year-on-year in December, dropping from 2.6% in November, against expectations of a 2.6% print. Core inflation, which excludes food and energy, also came in lower than expected, rising by 3.2% annually in December, against a 3.5% reading in November and 3.4% anticipated. 

This coming week only minor fundamentals are scheduled to be released for the UK. Markets will focus on BOE Governor Andrew Bailey’s testimony on the Financial Stability Report on Wednesday. Before the Treasury Select Committee. Traders will follow Bailey’s speech closely for hints on the BOE’s policy outlook. 

TRADE GBP PAIRS

JPY

The Yen’s rally was halted on Tuesday as the rivaling dollar gained strength, and USD/JPY rose from 154.4 to 155.5. If the USD/JPY pair declines, it may find support at 153.1. If the pair climbs, it may find resistance at 156.7. 

The BOJ raised interest rates by 25 basis points after the conclusion of its monetary policy meeting on Friday. The BOJ raised its interest rate from 0.25% to 0.50%, its highest level since 2008. In addition, the BOJ adjusted its inflation projections upward, to reflect the depreciation of the yen and rising oil prices, hinting at more rate hikes down the road. Policymakers expect Japan’s inflation to rise to 2.4% in 2025, up from previous estimates of 1.9%, and above the central bank’s 2% target. 

BOJ Governor Kazuo Ueda hinted that the central bank will continue to raise interest rates if Japan’s economy continues to improve and the BOJ 2% inflation target is reached. Ueda emphasized, however, that the timeline of future rate hikes will depend on economic and inflationary conditions.

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 3.0% year-on-year in December from 2.7% in November, which was in line with expectations. 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.

TRADE JPY PAIRS

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Written by:
Myrsini Giannouli

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