Dollar Rally Continues

January 13, 2025
  • Strong U.S data and hawkish Fed officials have conspired to push the dollar to new cycle highs; the rise in yields is a global phenomenon; New York Fed inflation expectations for December will be reported
  • U.K. Chancellor Reeves acknowledged the market turmoil sparked by investor concern over the government’s difficult fiscal position; U.K. assets remain under pressure; ECB officials remain dovish
  • China reported firm December trade data; reports suggest that Korea’s National Pension Service has begun strategic currency hedging

The dollar rally continues in the wake of the strong jobs report. DXY is trading higher for the fifth straight day and made a new high for this cycle near 110.176 as U.S. rates continue to rise. Sterling continues to underperform on fiscal concerns (see below) and traded at a new low for this cycle near $1.21 and remains on track to test the October 2023 low near $1.2035. Elsewhere, the euro is trading lower near $1.02 as ECB officials remain dovish (see below), while USD/JPY is trading lower near 157.30 on some haven flows. More tariff noise is likely in the coming days and weeks but we continue to look through that and focus on the underlying fundamental backdrop, which remains unchanged. Simply put, the strong U.S. fundamental story of strong growth, elevated inflation, and a more hawkish Fed continues to favor higher U.S. yields and a stronger dollar. This week’s inflation and retail sales data should underscore this message.

AMERICAS

Strong U.S data and hawkish Fed officials have conspired to push the dollar to new cycle highs. The 256k NFP reading for December was not a fluke, as most other indicators point to a robust labor market. This is not surprising given ongoing strength in the economy. The New York Fed's Nowcast model is tracking Q4 growth at 2.4% SAAR vs. 1.9% last week and Q1 growth at 2.7% SAAR vs. 2.2% last week and will be updated again this Friday. Elsewhere, the Atlanta Fed GDPNow model is tracking Q4 growth at 2.7% SAAR and will be updated this Thursday after the data. Growth creates jobs, jobs create demand, and demand creates pricing power.

The rise in yields is a global phenomenon. However, there are clearly divergences and so we must stress that why yields are rising in each country is a very important distinction. In the U.S., yields are rising because growth remains strong, inflation remains elevated, and the Fed has pivoted more hawkish. Global demand for USTs at these higher yields remains robust. In the U.K., yields are rising because inflation remains elevated and the BOE has remained hawkish, but the crucial element of growth is missing here. With the U.K. economy slowing, the fiscal outlook worsens due to lower tax revenues and higher outlays (unemployment, borrowing costs, etc.). This loss of market confidence has led to a buyers’ strike for gilts. Other major economies are somewhere on the spectrum between the U.S. and the U.K.

New York Fed inflation expectations for December will be reported. Here, expectations have been creeping higher throughout the spectrum and mirrors a similar rise in private sector inflation expectations.

EUROPE/MIDDLE EAST/AFRICA

U.K. Chancellor Reeves acknowledged the market turmoil sparked by investor concern over the government’s difficult fiscal position. Still, Reeves reaffirmed that the fiscal rules set out in the October budget “are non-negotiable and we will take actions to ensure that we meet those fiscal rules.” The implication is that the government may have to announce tax hikes and/or spending cuts when it publishes its Spring economic and fiscal forecast on March 26, further dampening economic activity. We don’t think Reeves can wait until then and needs to come up with something quickly to regain market confidence.

Indeed U.K. asset remain under pressure. GBP is trading near its lowest level since November 2023 and is eyeing the October 2023 low near $1.2000. After that is the March 2023 low near $1.1805. Meanwhile, 10-year UK government bond yields traded as high as 4.90% today, the highest since August 2008 and reflecting deterioration in the U.K. fiscal prospects. This week’s U.K. economic data releases (November GDP, December CPI, and December retail sales) are unlikely to offer the positive surprise necessary to halt the sell-off in GBP and gilts. Sticky UK services inflation should keep the BOE on a very cautious easing path despite the PMI suggesting economic growth momentum has stalled.

ECB officials remain dovish. Chief Economist Lane stuck to the bank’s dovish guidance and noted “Probably more monetary easing is going to come in order to make sure the European economy grows.” Elsewhere, GC member Rehn said “Against the backdrop of disinflation being on track and the growth outlook having weakened it makes sense to continue rate cuts.” Lastly, GC member Vujcic said that in “general, expectations of gradual, meeting-by-meeting cuts are justified by what we see in the data and in our projections,” and added that “We are not dependent on the Fed or any other central bank. So I can only say that from what I see now, the near-term expectations of the markets seem justified.” Of note, the market is pricing in a 25 bp cut this month. However, we take issue with only 75-100 bp of total easing priced in. Given the weak economic outlook, the hawkish shift in market expectations is hard to justify.

ASIA

China reported firm December trade data. Exports came in at 10.7% y/y vs. 7.5% expected and 6.7% in November, while imports came in at 1.0% y/y vs. -1.0% expected and -3.9% in November. This was the strongest gain for imports since July and offers some faint hope that domestic demand is recovering. Meanwhile, China cannot rely on exports to sustain a recovery in economic activity and needs to stimulate consumer spending further. Of note, the trade surplus rose to $992 bln in 2024 and will surely inflame tensions with incoming President Trump.

Reports suggest that Korea’s National Pension Service has begun strategic currency hedging. The NPS is now selling dollars in the forward market after the won weakened past trigger levels set by the NPS last month. Reports suggest that the program will continue until the won gains “significantly” and that up to $50 bln may be sold.

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