Markets Brace for Policy Shifts and Oil Supply Concerns

Markets are still grappling with the complexities of President-elect Donald Trump’s policy proposals, with investors closely monitoring developments from his incoming administration. Meanwhile, oil prices surged over 3% on Monday, marking the largest daily gain since early October. The rally was driven by the U.S. authorizing Ukraine to deploy long-range missiles within Russia and a production halt at Norway’s Johan Sverdrup oilfield—Western Europe’s largest—following an onshore power outage, intensifying fears of supply constraints in the North Sea crude market.

ECB Policy Bets Shift Amid Trade Tensions and Euro Gains

Traders have scaled back expectations for policy easing by the European Central Bank (ECB) in the coming year, with options markets now pricing in 135 basis points of rate cuts through the end of 2025, down from 147 basis points last week. This adjustment reflects growing concerns about the potential impact of Donald Trump’s proposed tariffs on European goods, which could heighten the risk of an economic downturn in 2025 and 2026 while fuelling another wave of inflation.

The interplay between growth, inflation, and trade tensions adds uncertainty to the ECB’s outlook, potentially prompting a flexible policy response to navigate the unpredictability of a new trade spat. The euro has benefited from the repricing, strengthening for a second consecutive day against the US dollar—a milestone last seen three weeks ago. German Bundesbank President Joachim Nagel emphasized that trade-related inflation spikes might necessitate higher interest rates.

EUR/USD has moved further from the $1.05 level, nearing $1.06. However, short-term market sentiment remains bearish, with the 1-month delta risk reversal dropping to its lowest point since July.

Pound Mixed as Markets Eye BoE Testimony and Policy Uncertainty

The pound had a mixed start to the trading week, losing ground against pro-cyclical and high-beta currencies but gaining against safe havens. GBP/USD remains supported by ongoing USD profit-taking, with the pair nearing the $1.27 level. However, reduced expectations for Federal Reserve easing and uncertainty surrounding the Bank of England’s (BoE) policy stance could limit further gains.

BoE Governor Andrew Bailey and other policymakers are set to testify before Parliament’s Treasury Committee on inflation and the economic outlook. Their remarks could significantly shape market expectations regarding future interest rate cuts, influencing GBP/USD movements. Current market pricing suggests only a 15% chance of a BoE rate cut next month, with just over two cuts anticipated by this time next year. Meanwhile, pound options traders are preparing for higher volatility in 2024, driven by the U.S. presidential election outcome and rising trade and sentiment risks.