Power Shift Overshadows Inflation
Shortly after US inflation data sparked a rally in Treasury bonds and weakened the dollar, comments from Dallas Federal Reserve (Fed) President Lorie Logan reversed much of this effect, particularly for the dollar. Although Logan does not vote on monetary policy, she suggested the Fed should proceed cautiously with rate cuts due to inflationary pressures from robust demand and geopolitical factors. Meanwhile, Republicans have secured control of both the White House and Congress, providing President-elect Donald Trump with full authority over the elected branches of government.
US headline inflation rose in line with economists' expectations, increasing by 2.6%, up from 2.4% in September. The core Consumer Price Index (CPI) remained steady at an annual 3.3%. Despite persistent shelter costs, new rent indices indicate a slowing trend, with the annualised rate climbing 3.6% over the last three months, marking the quickest pace since April. The Federal Reserve will monitor this data closely, having already reduced its benchmark rate by 0.75 percentage points across two meetings, setting a target range of 4.5-4.75%. The probability of a further rate cut by the Fed in December rose to around 75% from 56% earlier on Wednesday, bolstering demand for short-term bonds and pushing yields lower. However, the Republican Party’s majority in the House is expected to make Trump’s agenda for tariffs and tax cuts easier to implement, helping the dollar reach a one-year high against a basket of currencies. Consequently, while Treasury yields on short-term bonds declined, the dollar strengthened, with the Fed on a defined path of rate reductions as Trump gears up for fiscal expansion.
Having climbed more than 6% over six weeks, attention is now on whether the dollar index can surpass 107, potentially paving the way for further gains, with 110 as a major psychological level. On the downside, strong support lies near the 200-day moving average around 104. Given the dollar’s impressive rally since October, momentum could start to fade, possibly leading to a pullback amid profit-taking.
Euro Breaks Below $1.06
The euro’s bearish outlook persists as the currency has fallen sharply below the significant $1.06 level against the US dollar. Investors have identified currencies likely to underperform under the Republican majority led by President-elect Trump, with the euro and yuan leading that list; the EUR/USD and CNY/USD pairs now show the highest 90-day rolling correlation on record.
The euro has depreciated by about 5% since late September, when markets began to price in a Trump presidency, pushing the EUR/USD pair into negative territory for the year. If this trend continues through December, it would mark the fifth time in seven years that the euro has weakened against the dollar. With less than two months left, currency investors will be watching for seasonal trends, Trump’s cabinet choices, and the results of Germany’s vote of confidence to assess the likelihood of EUR/USD reaching parity.
European economic data will need to show marked improvement to bolster the continent’s assets. Germany’s Council of Economic Experts, an independent advisory panel to the Chancellor, has downgraded its forecast for growth in Europe’s largest economy, which now appears set for its second consecutive year of contraction—a first since 2003.
Sterling’s Decline Deepens
The pound appears headed for its worst run since 2014 against the US dollar. GBP/USD has declined for six consecutive weeks and is poised for a seventh, marking a cumulative fall of over 5%. Since breaking below its long-term moving averages near $1.28, the downtrend has accelerated past $1.27, with the next support level found at the 100-week moving average of $1.26.
In line with other major currencies, sterling has been swept up in the dollar’s surge following the US election and Trump’s “red wave” victory, which posed a significant downside risk to GBP/USD. Domestically, UK inflation has dropped below the Bank of England’s (BoE) 2% target, although BoE officials remain cautious about ongoing pressures in the services sector and labour market. Catherine Mann, one of the more hawkish BoE policymakers, recently noted that the central bank can afford to hold off on rate cuts until there is clear evidence of easing inflationary pressures. Market expectations reflect this caution, with only a 16% chance of a BoE rate cut in December and just two quarter-point cuts fully priced in by the end of 2025—suggesting the BoE could lag other central banks in easing.
This relatively hawkish stance has been supportive for sterling in 2024, helping GBP/EUR reach over two-year highs near €1.21. However, downside risks remain if services inflation continues to decline, which could lead to a dovish reassessment and a negative impact on the pound. Mann further noted that she is prepared to “act boldly” on rate cuts when conditions warrant, which could catch markets, and sterling optimists, off guard.
