The financial landscape remained relatively calm in the currency markets, despite significant fluctuations in the bond markets. Ahead of Donald Trump’s inauguration, the dollar showed little change last week, even after a softer-than-expected US Consumer Price Index (CPI) report for December led to lower US interest rate expectations, providing relief for bond and equity markets.
Analysts at Capital Economics suggest there could be greater volatility this week, with expectations high that Trump’s swift action in his second term will influence market reactions.
Capital Economics notes that with the economic data calendar lighter and the Federal Open Market Committee (FOMC) entering a quiet period before its policy meetings, Trump’s policies are likely to dominate the financial story next week. The company claims that Trump’s tariff policies are not fully reflected in current market prices, signaling a potential rise in the dollar if sweeping tariffs are implemented.
However, the company also recognizes the risk of disappointment for the dollar if these rates do not materialize as quickly as expected.
In Japan, currency markets are also preparing for the Bank of Japan’s (BoJ) policy announcement on Friday. The yen has put in a strong performance this week following official statements suggesting a possible 25 basis point rate hike. Capital Economics’ Japan Economics team has updated their forecast and now expects a rate hike sooner than initially thought in March, with money markets assigning a probability of around 80% to this outcome.
The focus now shifts to the BoJ’s future policy signals as they aim to manage market expectations without causing disruptions, similar to the market turbulence following the BoJ’s previous rate hike in June.
At the other end of the currency spectrum, the British pound has lagged other major G10 currencies for the second week in a row. Weaker-than-expected inflation and activity data in Britain have eased pressure on the government bond market, resulting in lower yields.
Nevertheless, the pound has suffered from the decline in UK interest rate expectations, and the market remains cautious about the UK risk premium. Capital Economics believes money markets are underestimating the level of easing expected by the Bank of England (BoE) this year, leading to a less optimistic outlook for the pound’s performance.
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