The Unending Dollar Rally Continues Another Week, Driven by Higher U.S. Bond Yields and Signs that the World’s Largest Economy is Gaining Momentum Again.
Key Points:
- The USD remains on top after sharp movements in the debt market.
- 10-year U.S. yields are rising following strong data and a shift in rate expectations.
- The GBP sinks amidst turbulence in the debt market.
The prospect of any Federal Reserve rate cuts this year is quickly fading, and the key yield on 10-year U.S. Treasury bonds has increased by a huge 120 basis points since the first rate cut in September – a reaction that is at least unusual following the Fed’s policy easing. Emerging market currencies are also under pressure, although the pound was definitely the biggest loser last week, its decline exacerbated by a troubling sell-off in government bonds. On the other hand, the Brazilian real managed to end the week unchanged against the U.S. dollar, thus strengthening against almost every other major currency – this may indicate that the brutal sell-off of the currency at the end of 2024 made the real attractive again.
Inflation data from the USA and the UK this week (on Wednesday) will be absolutely crucial for the markets. Investors in the treasury bonds of these countries are anxiously watching the flood of new debt that governments must place on the market, and a core inflation solidly above 3% doesn’t help. For now, higher market interest rates support the dollar, having the opposite effect on the pound. In the eurozone, this week looks to be calm, so the euro should mainly react to external news.
PLN The zloty ended the week slightly strengthened against the euro, but its performance was not particularly impressive – most emerging market currencies fared better than it. External information and the behavior of the EUR/USD pair remain crucial for the currency; markets await the inauguration of Donald Trump’s presidency scheduled for exactly one week from now.
In the coming days, investors will partly focus on the domestic situation due to the first meeting of the Monetary Policy Council this year. After a somewhat surprising hawkish pivot by President Glapiński in December (which suggested no rate cuts until 2026), markets should be particularly sensitive to signs that this was an exaggeration, not a real strong signal of a course reversal by the MPC. Like the markets, almost all economists – including us – expect resumption of cuts this year, the discussion focuses on timing and scope.
It’s also worth noting that the date for the presidential elections has been set, with the first round planned for May 18. Their impact on the market should be significantly more limited than that of the parliamentary elections. However, a market reaction wouldn’t be surprising, especially if the current favorite, Rafał Trzaskowski, experienced a clear drop in support in the polls. This would signal to investors that governmental-presidential frictions might continue and be a factor blocking reforms.
EUR Another challenging week for the euro. The common currency weakened against the dollar, supported by rising U.S. bond yields and another strong U.S. labor market report. However, it should be noted that bond yields have also risen in the eurozone. Moreover, the disparity between the two economies in this regard has been decreasing for some time, which should support the common currency. The macroeconomic readings published last week were also somewhat favorable, especially unemployment data and revised PMI figures, which may give investors very cautious optimism about the prospects for the eurozone economy.
The core inflation measure remained at 2.7%, where it has been for four months. Attention was drawn to the rise in the headline measure, which reached the highest level since July – we expect this to be one of the main topics discussed at the upcoming ECB meeting (January 30). With weakening pressure from the bond market and unquestionably low current valuation of the currency, even moderately positive news from the common bloc may help stabilize the euro.
USD The December NFP report from the U.S. labor market was very strong and confirmed that the Federal Reserve might have a problem justifying any further rate cuts, at least for now. Markets are pricing in just over one cut for the entire year of 2025, which in practice means that there may be no cuts at all this year.
After a period of significant weakness in U.S. fixed-income instruments, attention shifts towards this week’s inflation reading. Economists expect a drop in the monthly measure from around 3-4% annualized, which we have recorded for four months, to a more Fed-friendly 2-2.5%. If this does not occur, we may see further turbulence in the U.S. bond market, already having to contend with a significant increase in demand driven by a ballooning fiscal deficit. A key moment for the currency market will be when this sell-off of treasury securities starts to weigh on the dollar, rather than support it, as has already happened in the UK.
GBP Although the scale of movements in the bond market is not comparable to what we observed in 2022 following the announcement of Liz Truss’s consequential mini-budget, a sell-off of 25 basis points in just a week is still noteworthy. Moreover, it was a week in which we received neither key macroeconomic publications nor significant political news. The pound did not respond well to it, weakening by over 1% against almost all European currencies. It seems that this is a somewhat delayed reaction to the details of the autumn budget, and investors are starting to worry about the impact of government fiscal policy on public finances and the economy.
We believe the situation is much more favorable for the pound than after Truss’s budget disaster. Favorable are certainly both the high levels of interest rates of the Bank of England and the prospect of improved trade relations with the EU. It seems increasingly certain, however, that the Labour Party must decide on some kind of spending cuts to stabilize the British government bond market, which remains very vulnerable to any negative inflation surprises.
Authors: Enrique Diaz-Alvarez, Matthew Ryan, Roman Ziruk, Michał Jóźwiak – Ebury analysts
Source: https://managerplus.pl/kurs-dolara-kontynuuje-rajd-czy-presja-na-rynki-wschodzace-sie-utrzyma-76609
