Risk-On, Risk-Off
Currency traders have raised the likelihood of a Federal Reserve (Fed) interest rate cut this month to 86%, following Friday’s mixed US employment report. The next major data point will be November's US inflation figures, due on Wednesday, as Fed officials observe a blackout period ahead of the central bank’s meeting a week tomorrow. The US dollar has edged lower alongside Treasury yields, though geopolitical tensions are tempering its decline, as markets fluctuate between risk-on and risk-off sentiment amid developments in China.
Despite the dollar’s recent loss of momentum—having fallen nearly 2% since its November peak—driven by growing expectations of future Fed rate cuts, it remains a favoured safe haven during periods of heightened geopolitical uncertainty. While China’s most significant monetary easing in over a decade has supported risk assets, its intensifying trade conflict with the US has curbed broader risk appetite. China recently announced it would cut off key drone supplies to the US and Europe, which have been instrumental in Ukraine’s defence against Russia. This escalation in geopolitical risks, alongside tariffs and protectionist policies, is likely to keep currency market volatility elevated. Still, attention also remains on macroeconomic and monetary policy trends.
Although the US dollar and short-term Treasury yields have diverged somewhat since the US elections, their positive correlation remains unusually strong. This dynamic could spell trouble for the dollar if falling yields continue to fuel rate-cut expectations over the coming year.
Additional Stimulus from China
The euro has climbed well above the $1.05 level, recovering from its yearly low near $1.0330 reached at the end of November. European developments continue to weigh on the currency, with political uncertainty and disappointing macroeconomic data presenting challenges.
The euro’s rebound can largely be attributed to shifts in US markets, where a peak in surprise economic data, lower bond yields, and a moderation in Fed expectations have prompted a repricing of the dollar. This adjustment has benefited the EUR/USD exchange rate.
A potential driver for further recovery lies in China. Beijing has pledged to bolster economic growth in 2025 through increased fiscal stimulus and a moderately loose monetary policy. These measures aim to offset the negative effects of heightened US tariffs. Investors are optimistic about further supportive announcements during the Central Economic Work Conference on Wednesday. While Chinese equities surged by approximately 3%, the rally in European assets lost momentum during Monday’s session.
Key Resistance for Sterling
The pound strengthened at the start of the week, moving in tandem with other risk-sensitive currencies following China’s shift towards a looser monetary policy. Sterling shook off weak UK labour market data and gained from improved global risk sentiment, with GBP/USD nearing $1.28 and GBP/EUR approaching €1.21.
UK labour market surveys revealed the fastest decline in job vacancies since August 2020, as businesses face the dual pressures of rising employee costs and a subdued economic outlook. Business confidence, according to BDO, has fallen to its lowest level in nearly two years. The slowing jobs market, combined with a larger pool of candidates, could ease wage pressures, which would be welcomed by the Bank of England (BoE). However, it may also lead to a more dovish monetary stance for 2025 than markets currently anticipate, potentially weighing on the pound.
Sterling remains supported by relatively high yields compared to most of its G10 peers, but any dovish reassessment of BoE policy could weaken the currency. The 200-day moving average for GBP/USD, currently at $1.2819, acted as a resistance point during Friday’s bounce following the US jobs report. A break above this level would be a key technical milestone, potentially paving the way for further gains in the pound and pushing GBP/EUR past €1.21.
