Trump's Triple Victory

Early optimism that US President-elect Donald Trump might adopt a pragmatic approach in office now appears to be fading, giving way to a more aggressive interpretation of his policies. Proposals for tariffs and appointments to key positions are unsettling investors. European equity futures are showing a downturn, following Asia’s overnight losses, while the US dollar continues its rally—breaking past 155 against the yen and potentially prompting Japanese intervention to stem its currency’s decline.

As the results of the US election continue to ripple through global markets, Republicans are projected to maintain control of the House of Representatives, handing the party comprehensive control in Washington and delivering Trump a “triple victory.” This development has intensified concerns in financial markets that Trump’s policies could drive inflation, which may force the Federal Reserve to delay or moderate its rate-cutting cycle. Currently, traders are anticipating roughly two Fed rate cuts by June, down from nearly four expected at the start of last week, further boosting the dollar as US bond yields hit multi-month highs. Beyond the election, the US economy’s strength, reflected in a record-high optimism index from October’s NFIB small business survey, supports this strong dollar trend.

Today’s US inflation data release will be the next potential trigger for volatility. Core inflation is projected to have remained steady at 3.3% in October for the second consecutive month, after reaching a low of 3.2% in July. The Fed will be closely watching this first hint of a potential reversal in the broader trend of disinflation observed over the past year or so.

Continued European Underperformance

European markets remain under pressure as political uncertainties, both local and international, and renewed concerns over economic growth weigh on assets. Investor confidence in Germany saw a steeper-than-expected fall in November, as uncertainty grows regarding potential coalition challenges and Trump’s White House victory.

Prior to the US election, roughly 44% of German industrial companies believed Trump’s win would harm their business, yet only about 4% had taken proactive measures to mitigate these risks, according to the Ifo Institute. Political concerns are compounding the issue of weak demand, with approximately half of German companies reporting insufficient orders. Adding to this bleak outlook, yesterday’s ZEW survey showed the sub-index for the current economic situation falling to its lowest point since the early days of the pandemic in 2020, now at -91.4, marking its fifth-lowest reading since 2005.

The EUR/USD continued its decline for a third consecutive day, holding just above the $1.06 level, inching closer to its yearly low as European stocks underperform relative to their US counterparts. The Stoxx 600’s year-to-date gain slipped below 5% for only the second time since April, while the S&P 500 remains roughly 25% above its starting level for the year. This continued European underperformance weighs on sentiment as investors contemplate whether US equity markets may outshine others globally for yet another five-year stretch.

Pressure on the Pound

The British pound is struggling, consolidating near multi-month lows against the US dollar after breaking below key support levels, including long-term moving averages. Fresh demand for the dollar this week, fuelled by Trump’s appointment of hard-line trade advisers signalling support for substantial import tariffs, has added to the downward pressure on the pound. The pro-cyclical pound is also seeing broad selling as questions linger about the Bank of England’s (BoE) pace in easing policy.

Despite recent data showing stronger-than-expected wage growth in the UK, an unexpected rise in unemployment is weighing on sterling. With the job market showing signs of cooling, the BoE could consider bringing rates closer to neutral. Yet, the risk of inflation rebounding, further complicated by Trump’s anticipated policies, adds complexity to the BoE’s decision-making. The BoE has indicated a gradual approach to rate reductions, with overnight index swaps currently pricing in around 63 basis points in cuts by December 2025, compared to the Fed’s expected 70 basis points. This divergence could prove to be a misalignment, given both economies’ potential for higher inflation under Trump. In the short term, however, the UK-US 2-year real yield spread could offer some support for sterling, which appears to be approaching oversold levels on the daily chart.

Elsewhere, the pound is hovering near the €1.20 mark against the euro. The UK may face fewer direct tariff risks than the Eurozone, owing to its trade deficit with the US in goods. Moreover, the UK’s stronger cyclical fundamentals and supportive fiscal-monetary policy mix could boost sterling against the euro, potentially creating a favourable outlook for GBP/EUR heading into 2025.

Piling into Trump Trades

The extension of so-called “Trump trades” reflects investors’ confidence that President-elect Donald Trump will take swift action this time around, implementing his policies more rapidly than in his previous term. The US dollar continues to surge, reaching new multi-month highs against a range of currencies, while equities soar and cryptocurrency experiences a record-breaking rally in response.

Trump’s policies—aimed at a trade dynamic that favours the US and a more aggressive fiscal stimulus—are expected to further strengthen the near-term economic performance of the US relative to its G10 peers. Economic momentum has swung back in favour of the US, prompting a hawkish re-evaluation of the Federal Reserve’s interest rate cycle, which is decidedly dollar-positive through both tariff and fiscal-monetary policy channels. Despite the anticipation of increased protectionism, investor appetite for risk remains strong. Equities continue to rally to all-time highs, and notably, the cryptocurrency market is booming, with several digital assets surging by over 100% this month.

Bitcoin’s record-breaking rally saw it surpass $89,000, pushing the total crypto market value above its peak during the pandemic. Some analysts are predicting Bitcoin could reach $100,000 by year-end.

A Long List of Tail Risks

Global equity benchmarks are on the rise, and volatility indices are falling, yet the euro continues to struggle to attract buyers. Republicans in the United States are close to achieving a “trifecta” by winning control of the White House and both chambers of Congress, which—coupled with expectations of rate cuts and deregulation—has led to US equities outperforming their global counterparts. Meanwhile, increased tariffs under Trump are encouraging investors to favour the US dollar over trade-sensitive currencies like the euro.

Domestically, expectations of a further 25-basis-point rate cut from the European Central Bank in December and political instability in Germany are adding additional pressure on European assets. EUR/USD is doubly affected by the simultaneous expectation of European underperformance and US outperformance. The currency pair is on track for its second consecutive monthly decline, dropping below the $1.07 mark and hovering at 4.5-month lows as traders assess the potential for further downside.

While not an immediate threat, rising energy prices are emerging as a potential risk heading into winter. Gas prices have surged to €44 per megawatt-hour, marking a record for the year, as colder weather and decreasing storage capacity drive demand for protection against further energy price increases. This is something to monitor closely over the coming weeks. For the week ahead, the ZEW sentiment index is the only notable release in Europe, but upcoming speeches from Federal Reserve officials and Wednesday’s US CPI report will likely play a larger role in shaping the euro’s direction.

Pound Tumbles after Mixed Jobs Report

GBP/USD has fallen to a 13-week low, breaking through support levels at both its 200-day and 200-week moving averages, reaching the lower end of $1.28. Although UK wage data came in slightly stronger than anticipated, the unemployment rate rose to 4.3% for July to September 2024, up from 4% in the prior three-month period and exceeding the forecast of 4.1%.

Initially, the market appeared to balance these two metrics. However, sterling has since faced broad-based selling pressure, opening lower against all its G10 peers in Europe. Despite the typical positive influence of swap differentials and a risk-on rally for the pound, sterling appears more responsive to developments in the US. Going forward, nominal yields are expected to be a key factor, with risks skewed in favour of the US dollar.

It is worth noting, however, that the UK is likely less vulnerable to direct tariff risks than the Eurozone, given its trade deficit in goods with the US. This arguably provides a positive tailwind for the pound against the euro. GBP/EUR remains above the €1.20 level this morning, after pulling back from over two-year highs reached yesterday.

GBP has surged to a two-year high against the Euro following Donald Trump’s election victory and the Republican Party’s control of Congress. This political shift has led markets to believe that Trump's proposed tariffs could impact the Eurozone more severely than the UK, given the Eurozone’s goods export reliance versus the UK’s service-oriented economy, which is less tariff-sensitive. While much of the market’s response to Trump’s win is priced in, further gains for the Pound remain possible, particularly if his policies prove more negotiable than anticipated.

The GBP/EUR exchange rate remains technically primed for more upside, with support above the nine-day and 50-day moving averages. The Relative Strength Index (RSI) at 60 suggests potential for further growth, with a target range of 1.2120–1.2190 by year-end. The upcoming UK wage and employment data will be pivotal for the Bank of England’s rate decisions, as markets anticipate a slight rise in unemployment and a modest dip in earnings, which could support the case for a rate cut in December if inflationary pressures allow.

Meanwhile, the GBP/USD exchange rate faces pressure as the Dollar strengthens on Trump's win and an increasingly USD-supportive economic agenda. Despite this, the Pound has shown resilience, consolidating between 1.30 and 1.2834, with solid technical support near the 50% Fibonacci retracement at 1.2868 and the 200-day moving average at 1.2816. U.S. inflation data, a key focus for markets this week, could further support the Dollar if it surprises to the upside, while a softer reading might revive expectations for future Fed rate cuts. In the UK, Chancellor Rachel Reeves’ budget, with increased employer taxes, complicates the Bank of England’s options, with Bank Governor Andrew Bailey’s comments expected to shed light on how the Bank plans to balance growth and inflation amid recent policy shifts.

Trump’s Pro-Growth Policies Are Complicating Powell’s Path Forward

President-elect Donald Trump’s pro-growth agenda is presenting new challenges for Federal Reserve Chair Jerome Powell as he navigates the upcoming year. The Fed’s recent decision to lower interest rates by 25 basis points to 4.5% was expected and free from political influence. However, indications suggest that the December meeting could present more complexities. Over the past year, the Fed has reduced rates by 75 basis points to support ongoing economic growth. While the committee has observed a general easing in labour market conditions, it notably removed previous mentions of slowed job gains. Similarly, the statement expressing confidence in inflation’s movement toward the 2% target was also omitted. These changes have led investors to anticipate a potential rate cut delay, shifting expectations from December to January. Nonetheless, we believe another rate cut at the next meeting remains likely, given the time required for the administration to implement its proposed changes.

Uncertainty around government policy and the strong performance of the U.S. economy have led investors to substantially delay their expectations for rate cuts in 2025. Options markets now anticipate three more rate cuts before the Fed concludes the easing cycle at 3.75%. Trump’s growth-focused agenda, along with investors scaling back on rate cut bets, has driven the U.S. dollar to its highest level since July 2023.

Bank of England’s Rate Cut and Hawkish Outlook Signal Gradual Easing

The Bank of England (BoE) cut its benchmark interest rate by 25 basis points to 4.75%, as anticipated by markets. Eight out of nine policymakers supported the cut, with one dissenting. Following steep losses against the U.S. dollar on Wednesday, the pound recovered, pushing GBP/USD closer to $1.30, and GBP/EUR back to 1.20. However, sterling's drop against other high-beta currencies suggests that broader global sentiment and a cooling of “Trump trades” primarily influenced recent FX movements.

Despite the rate cut, the BoE’s tone was seen as hawkish. Policymakers stressed the need for a restrictive monetary stance, signalling a preference for a gradual easing approach. The central bank now forecasts inflation to rise from 1.7% to around 2.5% by year-end, with an estimated GDP increase of approximately 0.75% at peak impact within a year and a temporary inflation bump of nearly 0.5 percentage points. These revised projections reflect anticipated fiscal tightening following the UK Budget. Consequently, a rate cut in December seems unlikely, and traders foresee only two additional quarter-point reductions from the BoE by the end of next year, with just under a 50% probability for another cut.

Germany's Finance Minister Dismissal Sparks Euro Pressure and Potential Snap Elections

Chancellor Olaf Scholz's dismissal of German Finance Minister Christian Lindner has paved the way for potential snap elections early next year, adding fresh pressure on the euro. With the coalition now fractured, Germany faces increased uncertainty and reduced policy flexibility. Investors initially reacted by selling German government bonds, as Lindner’s replacement could signal greater bond issuance, diverging from his fiscally conservative stance. 

The euro remains highly sensitive to global developments, with EUR/USD trading near $1.0770 and showing a growing downside bias as analysts worldwide lower their year-end forecasts for the currency. The European Central Bank is likely to make deeper cuts than the Fed, and German growth is expected to stay sluggish next year. However, a drop below the $1.05 level is unlikely unless Trump enacts a broad 20% tariff on all U.S. imports.