18/01/2025 Market Analysis

Week Ahead: President-elect Trump's Inauguration

Recent days have witnessed significant macroeconomic developments that could shape the market landscape. Firstly, U.S. economic data exceeded expectations, with Q4 GDP projected to grow around 3%. Federal Reserve Governor Waller hinted at a potential interest rate cut in the first half of the year, which the market has largely priced in for the June FOMC meeting.

Secondly, guidance from Bank of Japan officials points to a likely rate hike at the end of the week unless unexpected market turmoil arises. Thirdly, UK Gilts experienced a significant yield increase, but this eased last week as the real sector underperformed and inflation softened more than anticipated, possibly due to survey timing issues.

Lastly, China's Q4 GDP met official targets, aligning with expectations. In response to new U.S. sanctions and a Section 301 investigation into China's maritime and shipbuilding industries, Beijing announced a probe into the U.S. semiconductor sector, focusing on alleged unfair subsidies under the U.S. Chips Act.

As markets brace for potential volatility, notable events include the inauguration of President-elect Donald Trump, which could bring immediate policy actions. The new administration's approach, particularly regarding tariffs, has already prompted retaliatory signals from other countries. Preliminary January PMIs will also be released, with the U.S. showing potential strength, while the eurozone is expected to remain in contraction.

The Bank of Japan's policy meeting concludes this week, with markets anticipating a quarter-point rate hike. Investors will closely monitor developments in the U.S., Europe, and Asia, alongside key discussions at the World Economic Forum in Davos, Switzerland.

United States of America

U.S. Economic Outperformance Supports Dollar

The U.S. dollar remains buoyant, underpinned by the robust performance of the U.S. economy, reducing the Federal Reserve's urgency to ease monetary policies. As market expectations stabilize, the next potential Fed rate cut appears likely around midyear.

Trump's Inauguration and Policy Uncertainty

The week kicks off with Trump's inauguration and the Martin Luther King holiday. The economic calendar includes preliminary January PMIs, regional Fed surveys, and existing home sales. The new administration is expected to launch numerous executive orders, with markets anticipating immediate impacts, including potential tariffs.

Dollar Index Trends and Indicators

The Dollar Index saw a strong rally, consolidating in recent sessions. Momentum indicators suggest the dollar's strength may persist, as it continues to hover above the 20-day moving average.

Implications of Trade Tariffs

Trade tariffs expected from the new administration could impact currencies like the Canadian dollar, Chinese yuan, Mexican peso, and the euro. These policies, along with anticipated tax cuts, are seen as inflationary, potentially boosting the U.S. dollar further.

Potential Crypto-Friendly Policies

Trump's expected crypto-friendly stance may fuel Bitcoin's rise, including plans for a strategic Bitcoin reserve, signaling a positive outlook for the cryptocurrency market.

Economic Data and Market Reactions

The week's light economic data includes key metrics like jobless claims, the University of Michigan’s final consumer survey, and existing home sales. These figures will be closely watched for insights into the U.S. economy and future interest-rate movements.

Key Points:

• U.S. dollar supported by strong economic data, with potential Fed rate cut midyear.
• Trump administration expected to initiate numerous executive orders, affecting markets.
• Dollar Index remains above key moving averages, indicating continued strength.
• Trade tariffs may impact global currencies, particularly in North America and Europe.
• Anticipation of crypto-friendly policies could boost Bitcoin.
• Key economic indicators include jobless claims, consumer sentiment, and home sales.

Australia

Correlation with the Canadian Dollar and Dollar Index

The Australian dollar (AUD) shows a strong correlation with the Canadian dollar (CAD), with a rolling 30-day correlation of 0.66. It also demonstrates a significant relationship with changes in the Dollar Index, with a correlation of about 0.60.

Impact of U.S. Interest Rate Differential

The AUD is sensitive to the two-year interest rate differential between Australia and the U.S. The AUD peaked near $0.6900 when the two-year yields were near parity. With a nearly 30 basis points discount currently, the AUD has recently hit its lowest levels since the early days of the pandemic.

Australian Economic Calendar Overview

Australia's economic calendar remains light, with the preliminary January PMI as the key highlight. The manufacturing PMI has been below the 50 boom/bust level since February 2023, while the services PMI has stayed above 50 since January 2024. The composite PMI ended Q4 2024 at 50.2 and dropped to 46.9 at the close of 2023.

Recent Performance of the Australian Dollar

The AUD faced follow-through selling after a stronger-than-expected U.S. jobs report on January 10. It hit a nearly five-year low around $0.6130, rebounding slightly midweek but declining again to a four-day low near $0.6165 before the weekend.

Technical Indicators for the Australian Dollar

A potential crossover of the five-day moving average above the 20-day moving average is expected early next week, marking the first occurrence since early October. Additionally, a downtrend line from the late September and early November highs was tested last week, beginning near $0.6230 and ending the week just below $0.6200.

Key Points:

• The AUD shows strong correlations with the CAD (0.66) and the Dollar Index (0.60).
• The AUD is influenced by the U.S.-Australia two-year interest rate differential.
• Manufacturing PMI remains below 50, while services PMI has stayed above 50 since early 2024.
• The AUD recently reached a nearly five-year low before slight recovery.
• Technical indicators suggest potential positive movements early next week.

Canada

Strong Performance Amidst Challenges

The Canadian dollar (CAD) posted nearly a 6% loss in Q4, making it the top performer among G10 currencies against the U.S. dollar. Although softer at the start of the year, it remains one of the best G10 performers.

Correlations with U.S. Economic Indicators

The CAD shows a strong rolling 30-day correlation with U.S. two-year yields and the spread over Canada's two-year yields. Its correlation with the U.S. Dollar Index is slightly higher at 0.52, while the link with oil price changes remains statistically insignificant. The CAD also maintains a modest correlation (~0.35) with the S&P 500.

Political Developments and Market Reaction

The potential leadership contest between Mark Carney and Chrystia Freeland for the Liberal Party has had minimal market impact. The Conservative Party is currently favored to win the upcoming election, though uncertainty remains about a confidence vote for a new Liberal leader.

Upcoming Economic Data

Ahead of the Bank of Canada meeting on January 29, three significant data points will be released:

1. Business Survey: The week kicks off with insights from the central bank's business survey.
2. December CPI: The base effect suggests a risk of the headline inflation rate surpassing 2.0%, which could influence the central bank's cautious stance.
3. November Retail Sales: Retail sales saw strong growth from July to October 2024, rising at an annualized rate of over 8%.

Recent USD/CAD Exchange Rate Trends

The USD/CAD exchange rate has been rangebound between CAD1.4280 and CAD1.4450 for most of the past month, with a recent breakout above CAD1.4475. The area around CAD1.45 could attract attention, with potential for a move toward the pandemic high near CAD1.4670.

Key Points:

• CAD led G10 currencies with a strong Q4 performance.
• Strong correlations with U.S. two-year yields and Dollar Index.
• Minimal market impact from Canadian political developments.
• Key economic data: business survey, December CPI, and November retail sales.
• USD/CAD exchange rate showing potential for further gains.

China

Weakening Yuan Due to Multiple Factors

The Chinese yuan has been under pressure from the strong U.S. dollar and disappointing economic data from China. The country’s poor-performing equity market and speculation about ongoing policy easing by the People's Bank of China (PBOC) have contributed to the yuan’s struggles. The yield difference between China's 10-year bond and the U.S. counterpart reached a record discount of about 315 basis points, narrowing to nearly 290 basis points in recent weeks.

PBOC’s Efforts to Stabilize the Yuan

The PBOC continues to manage the yuan's exchange rate closely. While the bank aims to avoid both a weak or a strong yuan, it generally wants the currency to remain stable against the U.S. dollar. By setting the reference rate, the PBOC tries to limit the extent of the dollar’s depreciation to around CNY7.3325. Since late September, despite the 10% rise in the Dollar Index, the yuan has risen less than half as much against the greenback.

Upcoming Loan Prime Rate Announcement

China will announce its one- and five-year loan prime rates early Monday. Despite a shift to a "moderately loose" monetary policy in December, economists see reduced chances of further rate cuts in the near term if the yuan remains under pressure. The PBOC has refrained from cutting the key lending rate since September, and analysts suggest that further easing may depend on market stability.

Market Reactions and External Risks

Barclays economists anticipate that the PBOC may not ease significantly until there is greater market certainty and stability. In the event of external risks, such as trade tensions, the central bank could ease more aggressively. Attention will also be on President-elect Trump’s inaugural address and potential impacts on China’s export-dependent economy, with tariffs being a key concern.

Key Points:

• Yuan under pressure due to a strong U.S. dollar and weak economic data.
• PBOC manages the yuan’s exchange rate to avoid large fluctuations.
• The one- and five-year loan prime rates are set to be announced.
• Barclays anticipates reduced chances of near-term rate cuts if the yuan remains under pressure.
• Market focus on potential impacts of trade tensions and President-elect Trump’s policies.

Europe

Weak Economic Indicators and Political Tension

The euro faces downward pressure due to weak growth impulses, political instability, and expectations of the European Central Bank (ECB) potentially reducing its deposit rate by at least 75 basis points in the first half of 2025. Europe seems unprepared to address a combination of external and internal challenges, including Russia's aggression, trade issues with China, the looming threat of U.S. tariffs, and internal political struggles highlighted in Draghi's recent report.

Key Economic Data Ahead

Two significant economic reports are expected in the coming days. First, Germany’s ZEW survey, set for January 21, shows that the assessment of the current situation has worsened for five consecutive months. The -93.1 reading in December was close to the pandemic-era low. However, the expectations component has improved in two of the last three months, with December reaching 15.7, the highest since August. The second major report is the preliminary January PMI at the end of the week. The composite PMI has fluctuated in a sawtooth pattern through the second half of 2024, finishing last year at 49.6, slightly up from November’s 48.2, which was the lowest since January.

Euro’s Struggles and Economic Weakness

The euro began last week by hitting its lowest point since November 2022, just below $1.0180. While it saw some recovery, those gains were limited, stalling near the 20-day moving average. The six-week decline in the euro ended with a minor 0.3% gain, but it still closed lower after four consecutive days of declines. The U.S. two-year premium over Germany eased to 200 basis points, the smallest since early November, but the euro was unable to capitalize on this, leaving it vulnerable to further declines.

Focus on Friday’s PMI Data

The primary focus for the upcoming economic data will be Friday's flash estimate purchasing manager indices (PMI) for France, Germany, and the eurozone. Concerns about regional economic weakness persist. A decline in the eurozone PMI is expected, with analysts noting that the December rebound in services activity may have overstated the region's dynamism. In manufacturing, the potential impact of a U.S. tariff hike on European businesses and rising bond yields could dampen expectations, although the ECB’s rate-cutting stance may limit the downturn.

Additional Economic Developments

Other notable data includes German producer prices on Monday and the ZEW economic sentiment indicator on Tuesday, which could signal further weakness in Germany's economic outlook. Additionally, Germany will hold bond auctions for various maturities this week, and other countries, including Slovakia and France, will also be conducting bond sales.

Key Points:

• Euro faces challenges due to weak economic growth, political instability, and ECB rate-cut expectations.
• Key economic data includes Germany's ZEW survey and the preliminary January PMI for the eurozone.
• The euro hit its lowest point since November 2022 and faces ongoing weakness.
• Friday's PMI data will be crucial in assessing economic conditions in the region.
• German producer prices and the ZEW indicator could highlight further economic concerns.
• Bond auctions in Germany, Slovakia, and France will attract attention this week.

Japan

Market Sensitivity to US 10-Year Yield and BOJ Policy

The exchange rate continues to be highly sensitive to fluctuations in the US 10-year yield and speculation surrounding the Bank of Japan's (BOJ) policy moves. Barring any major disruptions, it seems more likely that the BOJ will raise rates by 25 basis points. In fact, it could be more disruptive if the BOJ chooses not to hike.

Key Economic Data for Japan

Japan is set to release several important economic indicators. On Monday, final industrial production data for November will be released, showing a preliminary decline of 2.3% month-over-month. The tertiary industry index will also be reported. Wednesday will bring December trade data, with a strong seasonal pattern expected for improvement. The national consumer price index (CPI) for December will be released on Thursday, and the Tokyo CPI report from December 27 already indicated rising headline and core rates due to the end of household energy subsidies. The flash PMI data will also be released on Thursday, with Japan’s economy showing signs of improvement, as evidenced by the rise in the composite PMI in November and December.

Focus on BOJ Meeting and Economic Forecasts

The highlight of the week will be the BOJ's policy meeting concluding on Friday, with expectations of a rate hike. The BOJ is also set to update its economic forecasts, with speculation that the rise in rice prices and yen weakness may lead to an upward revision in its core CPI forecast. Currently, the core CPI forecast for the fiscal year is 2.5%, with 1.9% projections for the next two years.

Dollar-Yen Movements and BOJ Impact

The dollar has seen a correction, falling from nearly JPY159 in response to the US jobs data on January 10 to around JPY155 by the end of the week. This retracement met the 38.2% Fibonacci level of the dollar's rally from early December. The dollar's upside momentum has been weakening, but it has since recovered to around JPY156.50. There is initial resistance around JPY156.50, with a broader range extending to JPY157.40. If there is significant market volatility or comments from the US administration, the BOJ may choose to hold rates, potentially causing a sharp drop in the yen.

BOJ Rate Decision and Key Factors

The BOJ’s policy board will discuss whether to raise the policy rate from the current 0.25% at the upcoming two-day meeting. Governor Kazuo Ueda has cited wage trends in Japan and the outlook for US economic policies as key factors influencing the decision. Ueda’s comments suggest that strong pay increases resulting from annual wage negotiations could impact the BOJ's decision.

Inflation Data and Yen Weakness

Nationwide consumer inflation data for December is expected to show persistent price rises. Excluding fresh food, the CPI is forecast to have climbed 3.0% year-over-year, up from 2.7% in November. Given the yen's continued weakness, there is concern over higher import prices, and Japan's top currency official, Atsushi Mimura, will be speaking on Tuesday. His comments may offer clues about potential government intervention in the foreign exchange market to support the yen.

Upcoming Economic Events and Auctions

On Monday, machinery orders data for November will be released, and trade data for December will follow on Thursday. The Ministry of Finance will hold an auction on Tuesday for 700 billion yen in 40-year Japanese Government Bonds (JGBs), which are expected to attract demand from long-term investors like insurance companies and pension funds due to their high returns.

Key Points:

• The BOJ is expected to raise rates by 25 basis points, unless there is major market disruption.
• Key economic data releases include Japan's industrial production, CPI, and trade data.
• The BOJ’s policy meeting will be the focal point of the week, with potential rate hikes and updated forecasts.
• The dollar has corrected against the yen, but resistance remains around JPY156.50.
• Inflation data and yen weakness are central to economic discussions in Japan.
• Machinery orders and trade data will be closely watched, alongside JGB auctions for long-term investors.

New Zealand

Upcoming Inflation Data Release

Traders in New Zealand are closely awaiting the release of the fourth-quarter inflation data on Wednesday. The results will be crucial in shaping market expectations for future monetary policy moves.

Impact on Reserve Bank of New Zealand’s Policy

A major upside surprise in the inflation data would be required to disrupt the Reserve Bank of New Zealand's (RBNZ) planned course of action. The central bank is widely anticipated to continue reducing interest rates in February, following a well-telegraphed strategy.

Inflation Expectations

Economists predict that the inflation data will reinforce the need for further rate cuts, with annual consumer price inflation (CPI) expected to decrease slightly to around 2.1%, down from 2.2% in the third quarter.

Key Points:

• New Zealand’s Q4 inflation data release on Wednesday.
• The Reserve Bank of New Zealand is expected to continue cutting interest rates in February.
• Annual CPI is projected to drop slightly to 2.1% from 2.2%.
• A significant upside surprise in inflation could alter the RBNZ’s rate cut plans.

United Kingdom

UK Economic Outlook and Fiscal Credibility

Concerns over the UK's economic performance are increasing, with skepticism surrounding the government's fiscal credibility, which has been lingering since the Autumn budget. A sharp rise in UK 10-year yields since late November (~60 bp) has coincided with a significant decline in the sterling exchange rate against the dollar. Despite a slight dip in the 10-year yield from its peak in early January, sterling struggled to gain momentum.

Bank of England Rate Cut Expectations

Market expectations have priced in over a 90% chance of a rate cut at the February 6 Bank of England (BoE) meeting, with nearly 65 basis points of cuts expected throughout the year. Despite these expectations, sterling failed to capitalize on the softer inflation and real sector data, remaining under pressure.

Employment and Inflation Reports Ahead

The upcoming employment report on Tuesday is a key focus. Weekly earnings growth continues to be a primary concern for the BoE, given its role in sticky service inflation. The unemployment rate, which finished 2023 at 3.9%, has risen through 2024, remaining above 4% for much of the year. Additionally, the preliminary January PMI will provide an early glimpse into the UK’s economic activity for 2025.

Sterling's Recent Movements

Sterling weakened to nearly $1.21 at the start of last week following a stronger-than-expected US employment report. It recovered briefly to $1.23 midweek, but disappointing data, including November GDP and a surprise decline in December retail sales, pushed the currency back down. Sterling ended the week below $1.22, marking its lowest level since October 2023. Key levels to watch include $1.21 (targeting $1.20) and resistance between $1.2280 and $1.2340.

Key Points:

• UK 10-year yield has risen since late November, impacting sterling's performance.
• Market expects over 90% chance of a BoE rate cut in February, with further cuts expected in 2025.
• Employment data, wage growth, and public finance figures will be crucial in the coming days.
• Sterling weakened to below $1.22, with key support around $1.21 and resistance near $1.23.
• UK’s PMI data for January will be released on Friday, offering insights into 2025 economic activity.