n 3rd January, late in the London evening, a lack of liquidity in Tokyo due to a public holiday in Japan helped the Yen rally massively in a matter of minutes against most G10 currencies, only to give up nearly all of the gains just as fast. The Yen did top the G10 rankings over the holidays, but Sterling, the Euro and the US Dollar all ended more or less where they started.

The most important consequence of the Christmas rout in equity markets is the dramatic change in market expectations of Federal Reserve moves. Markets now expect no hikes at all into 2020, and are in fact pricing in a non-negligible probability of a cut. We think that this is at odds with the still strong data as exemplified by the December payrolls report in the US, and expect this move to partially reverse itself.

This should be a relatively data-light week, and focus will shift to politics: a potential trade deal between the US and China, and ongoing Brexit debate in UK Parliament ahead of next Tuesday’s government vote.

Major currencies in detail

GBP

All eyes are now on Parliament as it returns from recess today.

A first vote is expected next Tuesday (15th), and it’s widely expected to fail. The key will be whether the vote is close enough to warrant a push by Prime Minister May to try and get some concessions from the EU to push it over the line on subsequent votes. At this point, however, short Sterling positions are very crowded, as it is one of the most popular speculative trades out there. This means that any positive news on Brexit could generate a rather violent upward move in the Pound.

EUR

There had been some ominously weak sentiment numbers out of the Eurozone lately. The PMI indices of business activity have all posted significant drops, though they remain at expansionary levels for now. It is unclear to us how much of this reflects the general negativity around political conflicts with Italy, Brexit, and negative equity market sentiment. We will wait for this month’s numbers before we make any material changes to our outlook for the Euro and the Eurozone economy.

Data is light this week so we expect the common currency to trade mostly off of developments elsewhere.

USD

The violent swings in expectations for future Fed policy appear unjustified to us. The US payrolls report was extremely strong, with jobs created surprising to the upside. Critically, we are starting to see tightness in the labour market result in upward pressure on wages, which bodes well for consumer expenditures into 2019.

With no signs that a recession is in sight, we expect that the Federal Reserve will adopt a wait-and-see attitude, and are forecasting one or two more rate hikes in this cycle before Fed Funds settle into a 2.5-2.75% steady range. This stable but low level of rates should be supportive of risk assets in general, particularly the most beaten down emerging market currencies.