Dollar Rebounds
- A hawkish Fed hold this week can offer USD additional support. US equity futures are selling-off as China’s AI start-up shakes things up.
- US and Colombia stepped back from the brink of a trade war.
- China’s economic outlook worsened in January.
Please see our Drivers for the Week Ahead for an in-depth look at what markets are facing this week.
USD retraced some of last week’s losses and S&P500 futures are down more than 2%. USD recovered the most versus cyclical-sensitive currencies. Trade war jitters and sluggish Chinese economic activity are weighing on financial market risk sentiment. US stocks also slid as China’s AI startup DeepSeek is challenging America’s AI dominance on capability, cost, and openness.
The US and Colombia stepped back from the brink of a trade war on Sunday after “the Government of Colombia has agreed to all of President Trump’s terms, including the unrestricted acceptance of all illegal aliens from Colombia returned from the United States.” The episode highlights how the Trump administration will intertwine trade policy with national security policy. The bigger test of this strategy will be with China. Stay tuned…
In the meantime, China’s economic outlook worsened in January. The manufacturing sector is back in recession territory for the first time since September as the PMI dropped 1 point to 49.1 (consensus: 50.1); the non-manufacturing sector is stagnating with the PMI down 2 points to 50.2 (consensus: 52.2); and the composite PMI dipped 1.1 points to match a six-month low at 50.1.
China’s steady drip feed of stimulus will do little to improve the economy’s medium-term outlook, which we believe hinges crucially on addressing the huge debt overhang. Until that has been accomplished, growth will remain well below expectations and a structural headwind for commodity prices. The Lunar New Year holiday starts tomorrow, and mainland markets will be closed the rest of the week.
This week’s G10 central bank meetings will reassert the monetary policy divergence theme underpinning USD strength. The Fed is expected to keep rates steady at 4.25-4.50% and signal no rush to resume easing (Wednesday). The Bank of Canada is expected to cut the policy rate 25bps to 3.00% following two consecutive 50bps rate reductions (Wednesday). The European Central Bank is expected to cut the policy rate 25bps to 2.75% and stick to its data-dependent guidance (Thursday). Finally, Sweden’s Riksbank is expected to cut rates 25bps to 2.25%.
Second-tier US economic data comes out today, with little influence expected on financial market implications. December Chicago Fed national activity index (1:30pm London), December new home sales (3:00pm London), and January Dallas Fed manufacturing index (3:30pm London).
Friday’s US January PMI was disappointing, but the details should keep the Fed very cautious. The composite PMI unexpectedly dropped 3 points to a 9-month low at 52.4 (consensus: 55.6). The breakdown showed the manufacturing sector is expanding again for the first time since June 2023 rising 0.7 points to 50.1 but services sector growth momentum plunged 4 points to a 9-month low at 52.8. Digging deeper, employment rose at the fastest pace in two-and-a-half years while inflation pressures intensified.
EUR/USD is lower near 1.0460 after testing a one month high of 1.0520 Friday. The German January IFO Business climate index is up next (9:00am London). In December, the headline index slumped to 84.7, the lowest level since May 2020, as the expectations gauge dropped to an 11-month low at 84.4. The headline is expected to recover one tick to 84.8, current assessment is expected to rise three ticks to 85.4, and expectations is expected to rise six ticks to 85.0. Risks are balanced given that in January, the German composite PMI improved to the 50 boom/bust threshold while the ZEW investor economic sentiment survey dipped.
