US
US-EU trade tensions are weighing on financial market risk sentiment. Global equity and bond markets are selling off while gold prices hit new record highs. USD is behaving unusual for a risk off phase, as it’s down against most major currencies, notably EUR. EUR/USD is up nearly 1.5% since Monday.
USD weakness likely reflects increased FX hedging by non-US investors holding US dollar securities, and not a “sell America” trade. Indeed, the US Treasury International Capital (TIC) data showed that in the twelve months to November, foreign investors accumulated a record $1569bn of long-term US securities (treasury bonds & notes, corporate bonds, equities, gov’t agency bonds).
The idea that the Eurozone can weaponize its Treasury holdings if trade tensions with the US escalate does not pass the smell test. The Eurozone is the largest foreign holder of US long-term Treasuries, with 21% of total foreign holdings. However, the depth of the Treasury market means that any coordinated sales by Eurozone investors would have limited impact on Treasury yields. Eurozone holdings of US long-term Treasuries account for less than 5.5% of total Treasury securities outstanding.
Over the longer term, loss of confidence in US trade and security policies, combined with political interference with the Fed’s independence threaten to accelerate the dollar’s declining role as the primary reserve currency. That’s a structural drag on USD.
In the near term, we expect USD to continue to trade within the range in place since June last year. Most major central banks are done easing, while the Fed has room to deliver additional rate cuts.
ADP employment change for the four weeks to December 27 is due today (1:15pm London, 8:15am New York). For reference, ADP employment printed at +41k in December driven in large part by gains in the non-cyclical education and health services (+39k).
The US Supreme Court (SCOTUS) decision on President Trump's use of emergency tariff powers could also come today. Online betting markets give 30% chance the court will uphold the tariffs.
A ruling against Trump's emergency tariff powers could see USD come under downside pressure while the Treasury yield curve would steepen further on heightened fiscal concerns. Over the next ten years, the tariffs to date are expected to raise about $2.7 trillion while the One Big Beautiful Bill Act will cost $3.4 trillion.
A ruling in favor of Trump's emergency tariff powers would likely be USD supportive at the margin because it would re-empower tariffs as a credible, unilateral economic weapon.
A muddled ruling, where the court grants limited emergency tariff and require only limited repayment, is another scenario. This would raise policy uncertainty. But the broader market impact should be contained because the administration can pursue at least five other, albeit more cumbersome, alternative legal avenues that will keep most of the tariffs in place.
UK
GBP is up versus USD and down against EUR. UK labor market conditions remain weak. The unemployment rate stuck to near pandemic-era highs at 5.1% vs. 5.1% in October, matching consensus and the Bank of England’s (BOE) projection. However, labor demand worsened as payrolled employment fell -43k in December and -184k over 2025. That’s the fastest annual pace of job cuts since 2021.
Importantly, easing wage pressures leaves room for the BOE to deliver additional cuts later this year. The policy-relevant private sector regular pay growth dropped to a five-year low at 3.6% y/y (consensus: 3.7%) vs. 3.9% in October and is tracking the BOE’s Q4 projection of 3.5%. The swaps curve price-in 80% odds the BOE delivers a total of 50bps of rate cuts to 3.25% over the next twelve months which is a headwind for GBP.
JAPAN
JPY is underperforming and JGBs plunged on concerns over a further loosening of Japan’s fiscal discipline. Yesterday, Japanese Prime Minister Sanae Takaichi confirmed plans to dissolve the lower house of parliament on January 23, with official campaigning to start on January 27 and voting on February 8. In parallel, Takaichi reinforced her already pro-stimulus agenda by pledging a two-year break on Japan’s 8% sales tax rate for food if she wins.
In our view, worries over Japan fiscal profligacy are overdone. Japan nominal GDP growth is running at around 4% and leading indicators point to an encouraging growth outlook, while 10-year government bond yields are closer to 2.3%. With growth comfortably exceeding borrowing costs, Japan can sustain primary budget deficits without putting its debt ratio on an upward trajectory. In this environment, fiscal sustainability is far less fragile than markets currently imply.
CHINA
USD/CNH is making fresh cyclical lows. China Q4 real GDP hit the government’s 2025 growth target of around 5%. Real GDP rose 1.2% q/q (consensus: 1.1%) vs. 1.1% in Q3 to be up 5.0% y/y vs. 5.2% in Q3. China’s growth target is a government-set growth goal used as a policy tool to guide economic/social planning rather than a reflection of underlying supply and demand dynamic.
As such, the quality and sources of China’s growth is more relevant for investors. From that perspective, China’s long-term economic health remains weak. Net exports continue to be the main growth engine, consumer spending is struggling to gain traction, and fixed-asset investment remains a drag.
Today, China unveiled a series of loan incentives to help boost domestic demand. However, three major structural constraints prevent any meaningful effort to increase the role consumption plays in China’s economy: low household income levels, high precautionary savings, and high levels of household debt.
In the meantime, a continued appreciation of China’s currency can help China stimulate consumer spending by boosting disposable income through cheaper imports. Bottom line: USD/CNH downtrend is intact.
