Last Friday, the US dollar index remained volatile due to the uncertainty of the policies of the incoming Trump administration. As of now, the US dollar index is quoted at 108.
US Treasury Secretary Yellen wrote to the US Congressional leadership on the debt ceiling issue.
The Japanese Cabinet approved a record budget of 115.5 trillion yen for the 2025/2026 fiscal year.
ECB Governing Council member Holtzmann: The ECB may consider waiting longer before the next rate cut.
German President Steinmeier dissolved parliament, paving the way for early elections on February 23 next year.
Canadian ministers went to the United States to "beg" for the cancellation of tariffs, and they would spend 1 billion Canadian dollars to solve the border problem.
We believe that the yen may remain strong in 2025, especially if the "Spring Fight" in the first quarter of this year can bring wage growth of 5% or more, which will consolidate the need for the Bank of Japan to continue its monetary policy normalization process, which means that the Bank of Japan may continue to raise interest rates in 2025. However, the trend of the yen is highly dependent on the level of front-end interest rates in the United States. If the policies implemented by Trump after taking office are more inflationary than expected, the yen may face the risk of a re-downward trend. In addition, our US interest rate team believes that by the second half of 2025, the market may reconsider the possibility of the Fed's interest rate hike. However, rising foreign bond reserves and Japanese bond yields, as well as the possibility of further rate hikes by the Bank of Japan, are expected to ease the yen's weakness in the next Fed tightening cycle. Taking these factors into consideration, we have slightly adjusted our target for the USD/JPY ratio to 150 by the end of 2025.
Since early November, the US 5-year to 30-year Treasury yield curve has been fluctuating in a certain range as market expectations of Fed rate cuts in the coming months have been reduced. Although the market, including us, had expected the Fed to take a hawkish rate cut at its December meeting, the message revealed by the policy statement, dot plot and Summary of Economic Projections (SEP) was more hawkish than expected. The Fed has become more cautious in considering the extent and timing of further easing. The Federal Open Market Committee (FOMC) also believes that the risks to achieving its employment and inflation goals are "roughly balanced." Therefore, we expect the Fed to cut interest rates twice in the first half of 2025 and pause rate cuts after the federal funds rate ceiling reaches 4%.
For these reasons, we believe that the U.S. Treasury yield curve will remain relatively stable in the short term, but may steepen in the second half of 2025. This is because the front-end interest rate has been anchored after the Fed stopped raising interest rates, and the improvement in economic growth momentum will push up long-term interest rates. Higher tariffs and stricter immigration policies will become the main factors for rising U.S. inflation. Combined with the increase in Treasury supply caused by the tax cut policy, these factors may increase the term premium of Treasury bonds.
Given the unfavorable short-term interest rate differential, it may take some time for the euro to recover against the dollar, said Kit Jukes, a foreign exchange strategist at Societe Generale, in a report. He said that Societe Generale's interest rate forecast shows that the euro will fluctuate between $1.03 and $1.06 in the first half of 2025, and will only rebound to $1.10 in the second half of the year. Possible improvement in eurozone growth, signs of weakness in the U.S. economy and clarity on the policies of President-elect Donald Trump could help the euro by the summer of 2025. However, he said: "We need to be patient." Analyst Michael Hewson: The Bank of England may be "unlucky" and it will be very difficult to achieve... In my opinion, the main question facing the Bank of England in 2025 is whether there is room for further rate cuts since the interest rate cut cycle started this summer, or whether a large rate cut is possible. Although the market has not yet priced in this possibility, this idea has begun to circulate in some corners of the financial market. In its most recent interest rate decision, the Bank of England seemed to think that the base rate would fall back to 3% by the end of 2025, but they also said that inflation may not fall back to their expected target level until 2027. In fact, the Bank of England faces many challenges in 2025. They not only need to pay attention to price levels, but also have to prepare measures to deal with slower economic growth. In addition, unemployment is likely to start rising sharply in the middle of next year, as inflation from wage growth is likely to remain stable for a long time.
The recent jump in UK wage growth to its highest level so far this year, coupled with a sharp drop in hiring, suggests that the Bank of England will face the dual challenges of employment and inflation next year, which may make it particularly difficult for the Monetary Policy Committee (MPC) to achieve its interest rate cut target in 2025.
GBP/USD has indeed fallen into a downward dilemma after breaking through 1.34 in September this year. In particular, after the announcement of the UK Autumn Budget in October, GBP/USD continued to fall to 1.2485, but fortunately did not fall further. However, suppressed by the 200-day exponential moving average (EMA) of 1.2825, its long-term outlook sends a bearish signal. Before failing to break through this level, I think GBP/USD is at risk of falling below 1.2480 and extending its decline, with the downside target at the recent low or even the 1.20 mark.
The US dollar index is currently surrounded by a lot of good news. After the US election, the general consensus is that "American exceptionalism" will continue to exist, which is also reflected in the position data. Especially among G10 currencies, the market's position on the US dollar has clearly turned long since November 5. Trump's policies are mostly favorable to US economic growth and inflationary, which well explains why the continuation of "American exceptionalism" has become a market consensus.
Therefore, unless the economic data of non-US countries shows a much better than expected improvement, or the economic data of the United States itself shows a fall beyond expectations, it is difficult to see a meaningful correction in the US dollar. Both of these situations are not within the scope of our basic assumptions. In fact, what investors need to pay attention to is how far Trump is willing to go on tariff policy in the next three months, because tariff policy has the most direct impact on foreign exchange changes. During Trump's first term, some targeted tariff policies were indeed implemented, but no general tariffs were implemented. Some argue that this time may be different, but the takeaway from the super election year of 2024 is that voters really hate inflation, and we suspect Trump will be prepared to implement policies that crush real incomes in the US. Of course, investor and consumer sentiment in non-US countries will be negatively impacted by the threat of tariffs, dragging down non-US economic growth. But we need to reiterate that the market seems to have priced in a large part of this expectation, so it is very difficult to quickly predict a dramatic move like EUR/USD reaching parity in the current economic and market conditions. In summary, we believe that the dollar will indeed strengthen further, with an expected 109.60 in the first quarter of 2025.
Following the hawkish turn of the Fed's December meeting, we raised our forecast for the terminal federal funds rate to 4-4.25%, well above market expectations. Calls for long-term dollar weakness are weaker than ever, although concerns about a widening US fiscal deficit occasionally resurface. We believe that private sector surpluses will prevent the dollar weakness story from coming true. And by the end of 2025, the Fed may have completely ended the easing cycle and turned to tightening, which will further support the dollar. However, given that the current valuation of the US dollar is close to its historical high, the upward momentum of the US dollar index may mainly come from the interest rate differential with non-US countries.
The eurozone HICP annual rate announced on January 7, 2025 may rise slightly to 2.42%. If we look at the sub-items, the core CPI annual rate excluding energy, food, alcohol and tobacco is expected to decline slightly. In the core CPI, service industry inflation may reach 3.76%, and the core commodity inflation rate will also rise slightly to 0.67%. The annual rate of energy inflation may rebound from -2% in November to 0.3%, while the annual rate of food, alcohol and tobacco inflation will reach 2.8%.
Looking at the countries, Germany's overall HICP is expected to rise slightly on a year-on-year basis, and the core CPI may fall slightly, mainly driven by the decline in service inflation. However, the annual rate of energy inflation may rebound to -1.3% from -3.6% in November. In France, the overall inflation rate is expected to rise to 1.9% year-on-year from 1.7% in November, but the core CPI will continue to fall to 2.12%. Energy inflation rebounded to 1.7% from negative growth in November.
Although we think the eurozone HICP will rise slightly in December, we expect it to cool down in the following months, consistent with our summary indicator of a significant decline in the monthly rate of underlying inflation in November. However, compared with the inflation data in December, we believe that the inflation data in the eurozone in January 2025 is more important, due to the high uncertainty of price resets and weight changes at the beginning of the year, which will affect our forecast timing of the eurozone reaching 2% inflation. For now, we think that the eurozone's core CPI will reach the ECB's target by the end of 2025, while the headline CPI will fluctuate around 2% for most of the year.