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Dollar romp continues as US labour report smashes expectations

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13 January 2025

Written by
Matthew Ryan

Matthew Ryan is Ebury’s Global Head of Market Strategy, based in London, where he has been part of the strategy team since 2014. He provides fundamental FX analysis for a wide range of G10 and emerging market currencies.

The relentless dollar rally continued for yet another week, fuelled by sharply higher bond yields in the US and signs that the world’s largest economy is, yet again, gaining momentum.

GBP

While the violence of the moves in the gilt market did not match what we saw in 2022 after the Liz Truss mini-budget, a 25bp sell-off in merely a week where no major economic or policy news was released is still a remarkable downdraft. The pound reacted poorly to the turmoil, falling against all of its European peers by 1% or more. This appears to be a delayed negative reaction to the details of the Autumn Budget, as investors fret over the impact of the government’s fiscal measures on the state of public finances and the economy.

We think that the backdrop for sterling is significantly better than it was after the Truss budget disaster: higher Bank of England rates are supportive, and there are credible prospects for a better relationship with the EU on trade, which investors clearly view as bullish for GBP. However, it appears increasingly necessary for Labour to deliver spending cuts in order to fully stabilise the UK sovereign bond market, which remains vulnerable to any negative surprises in inflation.

EUR

The euro had another difficult week against the dollar, driven down by higher Treasury yields and yet another strong payrolls report in the US. We will point out, however, that the rate increase in the Eurozone bond markets almost matched the move in the US, and that the yield gap has actually been narrowing for some weeks, which should be supportive of the common currency. Indeed, macroeconomic news out of the bloc last week was mildly upbeat, notably the latest unemployment data and revised PMI figures, which provides reason for very cautious optimism towards the Euro Area economy.

Core inflation in the Eurozone remains stuck at an annual rate of 2.7%, however, where it has been for the last four months, and ECB members will be closely monitoring the recent uptick in the main measure of inflation, which is back at its highest level since July. With the yield headwinds abating, and the currency at an undeniably cheap level, we think even marginally positive news out of the Eurozone would help stabilise the common currency.

USD

The US payrolls report for December was very strong, confirming that the Federal Reserve will struggle to find justifications for any further cuts, at least for the time being. In fact, markets are now pricing in just one 25bp rate reduction for the whole of 2025 that, in practical terms, probably rounds down to no cuts at all.

After the very poor performance of US fixed income markets generally, this week’s CPI report will be key. Economists are expecting the monthly core index to ease from 3-4% annualised levels, where it has printed for the past four months, to a more Fed-friendly 2-2.5%. Failure to do so may reignite turmoil in the US bond market, which already has to deal with the prospect of a wall of supply caused by a ballooning fiscal deficit. The key for the FX market will be the point at which this Treasury sell-off becomes a negative for the dollar, rather than a positive, as has already happened in the UK – we are not quite there yet.

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