Dollar's Dip: Is It a Real Sell-Off, or Just a Temporary Pause?
It seems the U.S. dollar took a bit of a tumble recently, but are we sure it's a sign of deeper trouble? Here at Aria, we're looking at the charts and thinking the dollar might just have some breathing room to bounce back today. We've seen Japanese bonds perk up, and there's a good chance U.S. Treasuries and stocks will follow suit later on.
But here's where it gets interesting... With President Trump heading to Davos, there's a glimmer of hope for a de-escalation of the Greenland situation and a calming of fears that Europe might start dumping U.S. assets. This could mean the EUR/USD pair might just dip back below the 1.1700 mark.
USD: A Little Stability Could Go a Long Way
Yesterday's dollar slide appeared to be a mix of ripple effects from the volatility in Japanese government bonds (JGBs) and worries about European investors trimming their U.S. Treasury holdings. While the turbulence from Japanese bonds certainly shook up global fixed income, the foreign exchange market's reaction wasn't quite so uniform. When bond yields climb – even if it's due to foreign market movements – it can put pressure on a currency, especially if investors are already feeling uneasy about a country's fiscal health.
Over the past year, we've noticed that three major currencies – the USD, GBP, and JPY – have sometimes moved in the opposite direction of their long-dated yields (specifically the 10-year to 30-year range). Interestingly, these were also the three worst-performing G10 currencies yesterday. What really caught our attention was how the British Pound (GBP) lagged even behind higher-risk currencies like the Norwegian Krone (NOK) and the New Zealand Dollar (NZD). This suggests that a country's fiscal situation might be playing a bigger role in currency movements than just general market sentiment.
And this is the part most people miss... We don't think this dollar sell-off is one you should be rushing to join. Japanese long-dated bonds saw a sharp rebound overnight, which has helped to alleviate one of the downside risks for the dollar during today's European-U.S. trading session. As a side note, S&P 500 futures are showing a 0.4% gain, while European equities seem to be finding it a bit tougher to recover.
The Greenland issue is set to be the main focus today, and there's a real possibility of tensions easing. This could provide some much-needed support for the dollar. President Trump is scheduled to meet with EU leaders in Davos today, and if the past year has taught us anything, it's that direct, face-to-face discussions are often the best way to smooth things over with the U.S. president. Before heading to Davos, Trump himself commented, “We’ll probably be able to work something out.”
Looking at the U.S. economic calendar, there are no major data releases scheduled for today that are expected to move the market. Even with the recent bond and equity sell-off, market expectations for a Federal Reserve rate cut remain largely unchanged (only about 6 basis points for March). This further reinforces our belief that the dollar is likely to see some upside today amidst a broader market stabilization.
Francesco Pesole
EUR: A Return Below 1.1700 Could Be on the Cards Today
A headline yesterday about the Danish pension fund AkademinerPension exiting its U.S. Treasury holdings briefly amplified concerns about a European exodus from U.S. assets. However, it's worth noting that the actual size of the fund's holdings was quite small in December, around $100 million. Markets don't seem to be carrying these concerns forward this morning. If the Davos summit leads to some geopolitical de-escalation, any gains seen in the Euro (EUR) could start to be pared back today.
Our assessment is that unless we see another spike in bond volatility – which isn't our primary expectation – the EUR/USD pair is likely to trade below 1.1700. This is especially true considering the current period, which is seasonally strong for the U.S. dollar, and the recent hawkish adjustments in front-end U.S. Treasury yields.
In the rest of Europe, we're also a bit cautious about pushing the rally in the Swedish Krona (SEK) much further at this moment. EUR/SEK is currently trading at a short-term undervaluation of over 2%, suggesting it might be due for an upward correction – we anticipate it could reach 10.80 – before resuming its medium-term depreciation trend.
Francesco Pesole
GBP: No Surprises in the UK Inflation Report
As we touched upon in the USD section, the British Pound's underperformance yesterday was, in our view, largely a reflection of the risks associated with importing bond volatility into a currency that has recently shown a negative correlation with longer-term yields due to fiscal concerns. With calmer markets this morning, EUR/GBP might experience some downward pressure and could fall back below 0.870.
Regarding the data, the UK inflation report for December, released this morning, didn't offer any significant surprises that are likely to sway the Bank of England's decision at their February meeting. Our UK economist, James Smith, points out that the BoE's preferred measure of "core services" inflation, which excludes volatile and indexed items, remained steady at 4.0% for the third consecutive month. The headline inflation rate accelerating slightly more than expected to 3.4% was partly influenced by a rise in food prices to 4.5%. While food prices are something the Monetary Policy Committee (MPC) is watching closely, they are still well below the BoE's forecast of 5.3%.
Francesco Pesole
CEE: Maintaining a Bearish Stance
While the Central and Eastern European (CEE) economic calendar is relatively quiet today, with the first significant data expected tomorrow and Friday, the global narrative is keeping the region quite active. Yesterday, we saw the full impact of the risk-off sentiment driven by U.S. tariff headlines, which CEE bond yields followed as expected, with steeper yield curves across the board. However, it's noteworthy that Eurozone front-end yields moved in a similar direction, so the interest rate differential didn't change much. At the same time, the surge in EUR/USD somewhat counteracted the risk-off mood, and by the end of the day, we didn't observe substantial movements in foreign exchange.
We're sticking with a bearish outlook for the next few days, primarily due to local factors and the market pricing in more rate cuts than the global picture might suggest. However, both global and local factors seem to point towards a weaker currency for the region. Today, attention will remain fixed on global developments and the discussions at Davos. We might see some easing of the risk-off sentiment and a calming of the markets, which should at least keep the region stable. It's likely that in the coming days, the focus will shift back to regional economic stories.
Frantisek Taborsky
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