25/01/2025 Market Analysis

Week Ahead: Monetary Policy & Market Focus

After a week dominated by U.S. politics following President Trump’s inauguration, market attention shifts back to monetary policy. Central banks take the spotlight with upcoming interest rate decisions from the Federal Reserve, European Central Bank (ECB), and Bank of Canada. While the Federal Reserve is expected to hold rates steady, the ECB and Bank of Canada are anticipated to cut rates by 25 basis points. Divergence in monetary policy has already been factored into market expectations.

Key U.S. economic data, including GDP figures and the PCE deflator, will be closely monitored. Forecasts suggest the U.S. economy grew at a 2.6% annualized pace in Q4 2024, though the Atlanta Fed estimates a stronger 3% growth. Meanwhile, Eurozone GDP is expected to show marginal growth of 0.1% quarter-over-quarter, following 0.4% in Q3. Inflation metrics, such as CPI and PPI, have already hinted at modest changes, with the PCE deflator likely to align with these signals.

In Asia, attention turns to economic updates from Japan and China during a holiday-shortened week, as Lunar New Year celebrations begin on January 28. Japan’s Tokyo CPI for January is expected to show an acceleration, while Australia’s Q4 CPI reading on Wednesday could influence expectations for the Reserve Bank of Australia to start an easing cycle next month.

The forex market continues to digest President Trump’s tariff rhetoric, which initially unsettled currencies last week. By week’s end, markets viewed these statements more as negotiation tactics. The dollar has seen a correction across several major currency pairs after peaking post-election, signaling a potential shift in momentum.

This week, market participants will also assess the ongoing impacts of U.S. policy developments, with any new comments on tariffs likely to draw scrutiny. Together, these economic events and data releases set the stage for potential shifts across global markets.

United States of America

Federal Reserve Rate Decision in Focus

The Federal Reserve is set to announce its interest rate decision on Wednesday. With evidence of a strong U.S. economy, rates are widely expected to remain unchanged. Market participants will pay close attention to any signals about potential future rate cuts. While money markets anticipate two rate cuts in 2025, the first is not expected until mid-year. Fed Chair Jerome Powell is likely to strike a cautious tone, emphasizing a data-driven approach without committing to specific actions.

U.S. Economic Strength Holds Steady

The U.S. economy continues to exhibit resilience, with fourth-quarter GDP data due on Thursday. Analysts forecast growth between 2.6% and 3%, consistent with the stable expansion seen over the past two years. Additional data releases, including new home sales, durable goods orders, consumer confidence, and the Case-Shiller house price index, will provide further insights into economic health.

Inflation Metrics Could Influence Policy

Key inflation data, including Friday's PCE inflation figures, will be crucial in shaping the rate outlook. Analysts predict a modest rise in headline inflation to 2.5% or 2.6%, while the core PCE rate may remain steady at 2.8%. Wage pressures are also expected to show signs of easing. However, inflationary risks from President Trump’s policy agenda, including potential trade tariffs, remain a concern.

Market Sentiment and Dollar Trends

The dollar has shown signs of weakness since peaking in mid-January. Technical indicators suggest further downside potential, with the Dollar Index breaking below key support levels. Market participants attribute this to a "buy the rumor, sell the fact" reaction following Trump's inauguration. Meanwhile, the Federal Reserve’s data dependency and muted inflation pressures may allow for a gradual reduction in policy restrictiveness.

Treasury Auctions and Upcoming Events

The U.S. Treasury will auction $69 billion in 2-year notes, $70 billion in 5-year notes, and $44 billion in 7-year notes early in the week. This coincides with the Federal Open Market Committee (FOMC) meeting and key data releases, making it a pivotal week for financial markets.

Key Points:

• Federal Reserve’s interest rate decision on Wednesday, with no changes expected.
• Fourth-quarter GDP data projected between 2.6% and 3%.
• PCE inflation data on Friday, indicating modest price increases.
• Additional economic reports: new home sales, durable goods orders, and consumer confidence.
• Dollar Index weakening as market sentiment shifts post-inauguration.

Australia

Focus Shifts to Australian Inflation Data

Australian bond traders are zeroing in on the release of fourth-quarter inflation data this Wednesday. The report is pivotal for determining whether the Reserve Bank of Australia (RBA) will move to cut interest rates at its February meeting. While core inflation is expected to remain slightly above the RBA’s 2%-3% target range, recent trends indicate a steady decline. The RBA has expressed growing optimism about achieving sustainably lower inflation in the near future.

Market Expectations for Rate Cuts

Financial markets currently assign a 70% probability to a rate cut during the RBA’s February 19 meeting. This would align Australian monetary policy with other central banks that have already adopted a more accommodative stance. However, many economists predict the RBA will hold off on rate adjustments, citing a robust labor market and stronger-than-expected employment growth.

Consumption and Economic Momentum

Tax cuts introduced in mid-2024, along with rising employment, have supported consumer spending, adding momentum to the Australian economy. Despite these tailwinds, a weakening Australian dollar could become a critical factor in the RBA's upcoming decision. Currency depreciation might also be influenced by global developments, including any policy shifts in the U.S., such as potential tariff reductions on Chinese goods.

Currency Sensitivities and Influencing Factors

The Australian dollar remains closely tied to the movement of the U.S. dollar, with its exchange rate highly sensitive to the two-year interest rate differential between the U.S. and Australia. Over the past 60 days, changes in the Australian dollar have shown a stronger correlation with gold prices than with commodity indices like the CRB.

Upcoming RBA Meeting

The RBA will convene on February 19, and this week’s data, particularly the quarterly CPI, will shape market expectations. While headline inflation may appear resistant to change, underlying metrics could show signs of moderation. Additionally, December private sector credit data, expected to be released shortly after the CPI report, will offer further insight into demand dynamics, which have consistently outpaced supply.

Technical Analysis of the Australian Dollar

The Australian dollar gained significant ground last week, breaking above the September downtrend line near $0.6235 and advancing by nearly a cent. This marked its strongest weekly performance since November 2023, with a 2.1% increase. While momentum indicators suggest the currency is nearing overbought territory, the next technical resistance levels are at $0.6400 and $0.6440.

Key Points:

• Fourth-quarter CPI data, crucial for the RBA's February policy decision.
• Market pricing indicates a 70% chance of a February rate cut.
• Strong labor market and tax cuts continue to bolster economic activity.
• Australian dollar’s sensitivity to U.S. dollar movements and gold prices.
• Upcoming RBA meeting on February 19, with focus on inflation and credit data.

Canada

Tariff Concerns Loom Over Canadian Markets

Canadian markets are closely monitoring potential developments regarding U.S. trade policy, especially recent threats of 25% tariffs on Canadian goods starting February 1. These tariffs could significantly impact Canadian growth and employment, creating additional uncertainty for the economy.

Bank of Canada’s Upcoming Decision

The Bank of Canada (BOC) is set to announce its interest rate decision on January 29, coinciding with the Federal Reserve's meeting. A 25 basis-point cut is widely anticipated, likely bringing the policy rate to 3%. The rate cuts come amidst sluggish growth, controlled inflation, and a rising unemployment rate. Economists suggest the BOC may proceed cautiously until U.S. trade policies become clearer.

Political Instability and Economic Impact

Canada’s political landscape remains unsettled as the Liberal Party prepares to choose a successor for Trudeau in March. Uncertainty surrounding the new leader’s ability to survive a confidence vote adds to the economic pressures. Early elections could further complicate the outlook, though they may be delayed until later in the year.

Aggressive Easing Cycle

The BOC has been among the most aggressive central banks in easing monetary policy, cutting the overnight lending rate by 175 basis points since June 2024. These cuts included two significant half-point reductions in the fourth quarter. Economists overwhelmingly expect another rate cut, with the swaps market pricing a 90% probability of a quarter-point reduction this week.

Currency Movements

The U.S. dollar experienced volatility against the Canadian dollar following tariff threats but ultimately closed the week nearly 1% lower—its largest weekly decline since August. If the Canadian dollar breaks through the CAD1.4260 level, it could strengthen further toward CAD1.42 or even CAD1.41, particularly if the BOC signals a potential slowdown in its easing cycle.

Key Points:

• U.S. tariff threats could heavily impact Canadian growth and jobs.
• The Bank of Canada is expected to cut rates to 3% on January 29.
• Political uncertainty surrounds Trudeau’s successor and potential elections.
• Aggressive rate cuts since mid-2024 highlight BOC’s proactive stance.
• CAD1.4260 is a key level for the Canadian dollar, with further gains possible.

China

China’s Economy Starts the Year with PMI Insights

Official PMI data, due on January 27, will reveal whether China’s economy is gaining momentum at the start of 2025. Economists expect manufacturing activity to expand for the fourth consecutive month, with the PMI anticipated to rise slightly to 50.2 from December’s 50.1. This continued expansion reflects Beijing’s stimulus efforts, while the non-manufacturing PMI is set to highlight strength in construction and service activities following a strong rebound in December.

Industrial Profits Under Scrutiny

Industrial profit data, also due on January 27, will shed light on the effectiveness of government measures to support growth. The figures will indicate whether industrial firms benefitted from these efforts in December 2024, offering insight into broader economic performance.

Market Sentiment Influenced by Tariff Concerns

Chinese markets remain in a delicate balance due to ongoing uncertainty around U.S. trade policies. While optimism over a potential reduction in U.S. tariffs has supported market sentiment, the lack of clarity continues to create swings between hope and pessimism. This “tariff limbo” is also evident in Chinese equities, which are caught between signs of improvement in the housing sector and mixed signals on trade.

Yuan Performance and PBOC Measures

The yuan has seen strength recently, supported by relief over a softer U.S. dollar and potential tariff reductions. The People’s Bank of China (PBOC) has actively managed the currency’s exchange rate, ensuring it remains stable despite external pressures. Measures such as lowering the reference rate have supported the yuan above recent lows. The greenback’s decline against the yuan last week marked its largest weekly loss since mid-2024, nearing key technical levels.

Upcoming PMI Releases and Market Closures

China’s official PMI data will be published on January 27, followed by Caixin’s manufacturing PMI on January 31. Meanwhile, the Lunar New Year holiday begins on January 28, keeping mainland markets closed until February 4. These developments will shape market expectations as investors navigate the first quarter.

Key Points:

• Manufacturing PMI is expected to rise to 50.2, indicating continued expansion.
• Industrial profit data will reveal the impact of stimulus measures on industrial firms.
• U.S. trade policy uncertainty continues to influence market sentiment.
• PBOC measures have stabilized the yuan, supporting it against recent lows.
• Lunar New Year holidays will keep Chinese markets closed from January 28 to February 4.

Europe

ECB Rate Cut Expected Amid Struggling Eurozone Economy

The European Central Bank (ECB) is set to hold its first meeting of the year on January 30, where a 25-basis-point interest rate cut is widely anticipated. As the eurozone economy grapples with a slow recovery, investors will be closely monitoring ECB President Christine Lagarde’s statement and press conference for insights into the trajectory of future rate cuts.

Eurozone Economic Data in Focus

This week, key end-of-month data will provide a clearer picture of the eurozone's economic health. Preliminary GDP and inflation figures, as well as various confidence surveys, are scheduled for release. Germany’s January Ifo business climate index will kick off the data flow on Monday, followed by France’s consumer confidence survey on Tuesday. Additional surveys from Germany, Italy, and the eurozone will follow throughout the week.

Spain’s Growth Stands Out

Spain’s Q4 unemployment data, due Tuesday, and preliminary GDP figures on Wednesday are expected to underline the country’s position as one of the eurozone’s more dynamic economies. Additionally, Spain will release flash CPI data for January on Thursday, ahead of similar releases from France and Germany on Friday.

Bond Auctions Highlight Regional Activity

Germany will launch new March 2027-dated treasury notes worth €5 billion on Tuesday and reopen its February 2035 Bund for €4.5 billion the same day. Italy is set to conduct auctions on Tuesday and Thursday, while the Netherlands plans a Tuesday auction. These events reflect the ongoing fiscal dynamics within the region.

Euro Gains Momentum Against the Dollar

The euro’s recent rally has been driven more by U.S. dollar movement than European developments. With stronger-than-expected PMI data pushing the euro to $1.0520 by the weekend, it marked its highest level in a month and a significant recovery from January 13 lows. Traders appear to be unwinding short positions, further supporting the currency. Technically, the euro could target the $1.0560-75 range if the upward momentum persists, though a drop below $1.0375 would signal a potential halt in the rally.

Key Points:

• The ECB is expected to cut interest rates by 25 basis points to 2.75%.
• Preliminary GDP and CPI data will provide critical insights into eurozone growth and inflation trends.
• Spain remains a bright spot in the eurozone, with robust growth potential.
• Key bond auctions by Germany, Italy, and the Netherlands will shape the week’s fiscal activity.
• The euro has gained 3.3% from mid-January lows, with technical indicators suggesting further upside potential.

Japan

Tokyo CPI to Indicate Nationwide Inflation Trends

Consumer inflation data for Tokyo, set to be released on Friday, is expected to provide insights into whether Japan's nationwide inflation can sustain levels above the Bank of Japan's (BOJ) 2% target. Economists project Tokyo’s core CPI, excluding fresh food, will rise by 2.4% in January, matching December's increase.

Key Economic Data Scheduled for Release

Japan’s December data on industrial production, retail sales, and employment is also due Friday, offering a broader view of the country's economic activity as it enters 2025. These figures may influence short-term market sentiment but are unlikely to shift BOJ policy expectations significantly.

BOJ Policy Insights Through Minutes and Transcripts

The BOJ will release minutes from its December 18-19 meeting on Wednesday, during which it maintained its policy rate at 0.25%. Additionally, transcripts from meetings held between July and December 2014 will be published, offering historical insights into the central bank’s decision-making process. This follows a 25-basis-point rate hike in January 2025, with the BOJ maintaining a cautious stance on further tightening.

Upcoming Bond Auctions Highlight Market Activity

The Ministry of Finance plans to auction 350 billion yen in five-year climate transition bonds on Wednesday, followed by a two-year sovereign note auction worth 2.6 trillion yen on Friday. These auctions underscore Japan's focus on supporting fiscal initiatives amid evolving economic conditions.

Yen's Exchange Rate Correlation with U.S. Treasury Yields

The yen’s exchange rate remains closely tied to the U.S. 10-year Treasury yield. A 60-day rolling correlation highlights its stronger influence compared to the spread between Japanese and U.S. 10-year yields. Despite the BOJ’s recent rate hike and upward inflation revisions, the dollar-yen pair has traded within a tight range of JPY154.80 to JPY156.75 since mid-January. A break below JPY154.80 could weaken the yen further, while an upside breakout could target levels between JPY157.30 and JPY158.00.

Key Points:

• Tokyo's January CPI data will hint at the sustainability of nationwide inflation above the BOJ's target.
• December data on industrial production, retail sales, and employment is due Friday.
• BOJ meeting minutes and historical transcripts will provide additional policy context.
• The yen’s exchange rate is heavily influenced by U.S. 10-year Treasury yields.
• Dollar-yen momentum remains range-bound, with key levels to watch at JPY154.80 and JPY158.00.

United Kingdom

Sterling's Recent Decline and Modest Recovery

Sterling depreciated nearly 10% from late September to mid-January, reaching a low of $1.21. Despite ongoing domestic challenges, including slower growth and a larger budget deficit under Labour’s leadership, recent market activity suggests some of these concerns have been priced in. The Chancellor of the Exchequer has hinted at revisiting unpopular fiscal decisions, potentially aiding sentiment.

Expectations for Bank of England Rate Cuts

The UK is set to release consumer finance data, including credit, mortgage lending, and house prices, which are unlikely to shift market expectations. The Bank of England is widely anticipated to reduce the base rate by 25 basis points at its upcoming Monetary Policy Committee meeting. Market pricing suggests further cuts in Q2, though expectations for the latter half of 2025 remain cautious.

Sterling’s Short-Covering Rally and Key Levels

After bottoming at $1.21, sterling has appreciated around 3%, briefly surpassing $1.2500 amid a weaker dollar. The next technical target lies near $1.2575, representing a 50% retracement of the decline since September, with further interest possible at $1.2610. Momentum indicators point to continued strength, supported by the five-day moving average crossing above the 20-day average.

Focus on Mortgage and Credit Data

This week’s UK data releases are limited, with mortgage lending, credit figures, and January’s Nationwide House Price Index due on Thursday. These figures are expected to provide insight into consumer finances but are unlikely to influence immediate monetary policy decisions significantly.

Upcoming Gilt Auctions Under Spotlight

UK government bond auctions may draw heightened attention following recent volatility in gilt yields, which spiked to multi-year highs before retreating. Scheduled auctions include the September 2035 index-linked gilt on Tuesday and the July 2033 green gilt on Wednesday, with investors closely monitoring demand amid concerns over public finances.

Key Points:

• Sterling has recovered 3% from January lows, with resistance levels near $1.2575 and $1.2610.
• The Bank of England is expected to cut rates by 25 basis points next week, with additional easing likely in Q2.
• Mortgage lending, credit data, and the Nationwide House Price Index are due Thursday.
• Gilt auctions could attract attention due to recent yield volatility and fiscal concerns.