Euro Struggles Amid Rising Inflation Concerns and Weak Economic Data
The euro failed to sustain its two-day winning streak that began on Friday, falling back below the $1.04 mark. Stronger U.S. macroeconomic data has heightened inflation concerns, driving longer-term Treasury yields higher and exerting downward pressure on the euro. In Europe, price pressures have started to build as well, tempering expectations of rate cuts by the European Central Bank (ECB). However, the weak growth outlook underscores looming stagflationary risks, challenging euro bulls as selling pressure persists.
Inflation in Europe rose for the fourth consecutive month in December, reaching a five-month high of 2.4%. Although the increase was stronger than anticipated, base effects explain much of the uptick, reducing the likelihood of a hawkish pivot from the ECB. Adding to the grim economic narrative, German factory orders dropped sharply by 5.4% in November, marking the second weakest month in a year.
This week, investors will monitor European economic sentiment, retail sales, and German industrial production data. However, the primary focus remains on Friday’s U.S. labour market report, which could further influence global market dynamics.
Sterling Faces Persistent Downtrend Amid Economic and Political Uncertainty
The British pound remains entrenched in a downtrend against the US dollar, a slide that began in October 2024. This decline coincided with improving polling for US President-elect Donald Trump, positive shifts in the US data surprise index, and diminishing expectations for Federal Reserve rate cuts. Conversely, the UK's poorly received autumn budget and disappointing economic data contributed to the pound’s weakness.
Over the past three months, GBP/USD has plunged approximately 8%, falling from $1.34 to a nine-month low below $1.24 last week. This week’s rebound stemmed largely from a weaker dollar, driven by tariff-related news, with stronger UK retail sales figures offering additional support. However, GBP/USD failed to breach its three-month downtrend line. While a close above $1.26 could signal a breakout, the pair has retreated below $1.25 following robust US economic data.
The UK’s fixed-income market also garnered attention this week. A lackluster 30-year bond auction pushed yields above 5.22%, their highest level since 1998, intensifying pressure on the Chancellor to stabilize markets. The Labour government’s plan to sell £297 billion in bonds this fiscal year—the second-highest on record—is keeping gilt yields elevated.
Adding to the uncertainty is a shift in market expectations for the Bank of England (BoE). Traders now anticipate only two quarter-point rate cuts this year, down from expectations of more than three last month. While fewer rate cuts could provide some support for the pound, a prolonged high-rate environment amid weakening economic conditions raises concerns about stagflation, which could limit sterling’s upside potential.
2025 Macro Strategy: Navigating Resilience, Tariffs, and Political Shifts
Looking beyond the short-term perspective, our broader macro strategy for 2025 considers key developments from the past year. In 2024, the global macro landscape was defined by the remarkable resilience of the US economy, buoyed by robust consumer spending and a strong labour market. This strength allowed the Federal Reserve to cut interest rates by 100 basis points, following a rapid decline in inflation over the prior 12 months.
Entering 2025, however, the macro outlook is shifting. President-elect Donald Trump’s potential implementation of higher tariffs, coupled with renewed inflationary pressures, is likely to make policymakers more cautious about further monetary easing. Current market expectations reflect this sentiment, pricing in only a single rate cut for the year—a stark contrast to the six cuts anticipated at the start of 2024.
We believe markets may once again misjudge the trajectory, though in the opposite direction this time. While the US economy remains resilient, the labour market is expected to weaken further. Additionally, recent reports suggest Trump may approach tariffs more pragmatically, which could pave the way for 2-3 rate cuts if inflation remains under control.
On the global stage, political developments are adding layers of complexity. Last year’s electoral shifts to the right have set the tone for 2025, with upcoming elections in Germany and Canadian Prime Minister Justin Trudeau’s resignation introducing uncertainty. While these events may offer temporary support for the US dollar, we remain cautious about the currency’s long-term upside. Ultimately, Trump’s tariff policies will exert a more significant influence than regional political dynamics, and we anticipate less dramatic tariff hikes than market consensus predicts.
