Thu, 02/27/2025 - 10:00
After a period of relative obscurity, the currency markets exploded into life over the past week as the world majors began to reverse the trend of dollar dominance that started following the results of the November presidential election. Both GBP/USD and EUR/USD all managed to gain a full 3% in February, while the yen strengthened by the same amount to bring USD/JPY below the key psychological level of 150. At the same time, the ten-year US Treasury note yield has dropped a full 0.25% in just five trading days, lending credence to the possibility of a full-scale forex paradigm shift taking place over the coming months.
The reasons for the reinvigoration of the global currency markets are manifold. Of primary import to both the scale and duration of the action will inevitably be the softness of the monetary policy of the key central banks and, of course, the extent of the nascent trade war between the US and several trading partners and its effect on both dollar trading volumes and international trust in the US national currency.
Softly, softly
After an extended period of above-average interest rates held steady in the 4.25-4.5% range for multiple months, it finally appears as if the US Federal Reserve might be ready to consider a softer approach to its monetary policy. The CME FedWatch tool now has the chances of a rate cut of at least 25 basis points (bps) in June at 50.0%, though some believe this could come even sooner if the still sticky inflation can be brought closer to the 2% target before then. Investors will, therefore, be paying close attention to Friday's (28/02) PCE inflation data, which is the Federal Reserve's preferred inflation gauge.
Falling T-note yields would suggest that institutions and "the smart money" are preparing for a more dovish policy stance and, thus, a weaker dollar on the horizon. This would explain the short-term gains for sterling, the euro, and even the yen, though local factors could have their own say in the coming weeks and months. A recent Reuters poll of leading economists, for instance, found that a majority estimate the Bank of England (BoE) will keep rates unchanged at 4.50% in March before making a cut to 4.25% in Q2. Meanwhile, would-be German Chancellor Frederich Merz wishes to remove the "debt brake" rule that limits the deficit to 0.35%, which would open the door for further easing by the ECB. Both of these factors will likely balance out any softening by the Fed and could encourage the normalisation of the majors by summer.
The Art of War
One of the biggest risks to not just the US but the global economy at large is the nascent Sino-American trade war. Trump has already initiated 25% tariffs on a range of Chinese goods, while the CCP has retaliated with levies of 10% and 15% on US coal and LNG. Trump is also looking to widen the scope of his sanctions to include a host of other countries, including two other major BRICs in India and Brazil. The impact of such a protectionist policy is not limited to the prices of commodities or even equities; they can also adversely affect the value of the US national currency. Not only will there be less international trade, which is performed largely in US dollars, but there will also be reduced confidence in the greenback as the global reserve currency and the migration to other means of bilateral transfer will accelerate.
While the US Dollar Index rose on tariff announcements during the first Trump presidency — gaining up to 10% in 2018 and 4% in 2019 — this was a time when the dollar was virtually unchallenged as a medium of international exchange and the disparity between US interest rates and the rest of the developed world was much larger. However, BRICS aren't the only party worried about US tariffs. ECB policymaker and Bundesbank President Joachim Nagel has stated that "strong export orientation" makes Europe "particularly vulnerable" to potential Trump tariffs, and the US president has yet to rule out aiming his favourite weapon at the EU. Much remains to be seen, but in addition to the damage to the dollar itself during a period of monetary easing and reduced trade, currencies like the euro, sterling, and yen could also suffer if exports are made less competitive by artificial tariffs.
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