Market Brief: Dollar Juggernaut Gains Momentum

The almighty greenback is trading near a two-year high after Friday’s non-farm payrolls report reinforced expectations for a prolonged pause in the Federal Reserve’s easing cycle. When measured against a basket of its most widely-traded counterparts, the dollar is at its strongest levels since November 2022, supported by ten-year Treasury yields that are inexorably moving closer to the 5 percent threshold that was last broken in October 2023. Most major currencies are down roughly three quarters of a percentage point from Friday's open, although the Canadian dollar is outperforming after December's surprisingly-large gain in jobs, and the British pound is underperforming all of its rivals.

December’s job report was unremittingly positive. According to the Bureau of Labor Statistics, 256,000 positions were added— substantially above the 160,000 consensus—the unemployment rate fell to 4.1 percent, the labour force participation rate climbed, and average hourly earnings held up with a 0.3-percent gain. Traders moved to price in less than 30 basis points in easing from the Fed this year, and raised “terminal rate” expectations across the curve, suggesting that a “no-landing” scenario has now firmly displaced any alternatives among investors.

Data released over the coming days could show the US disinflation process running out of momentum. December’s US producer, consumer, and import price data releases—set to land tomorrow, Wednesday, and Thursday, respectively—are expected to set the stage for a still-firm 2.8-percent print in the Fed’s preferred measure of price pressures—the core personal consumption expenditures deflator—at the end of the month.

Retail sales numbers, out on Thursday, might follow Friday’s non-farm payrolls report in surprising to the upside. Household incomes—a function of hourly earnings multiplied by the number of hours worked across the population—climbed at a solid pace in December, adding to an improvement in consumer sentiment to boost outlays on goods, particularly autos.

After a long hibernation, oil prices are ratcheting higher, supported by Friday’s expansion of US sanctions against Russia’s energy sector. Both of the major global benchmarks—West Texas Intermediate and Brent—are up roughly 5.5 percent from the Friday open after the Biden administration hit Gazprom Neft, Surgutneftgas, dozens of trading firms and oilfield service providers, and 183 transport vessels with additional sanctions. Although markets are believed likely to remain in oversupply this year, the marginal gain in prices could push inflation expectations higher in the US and other major economies.

Taken in combination, these factors could add fuel to the “tantrum” raging across global bond markets, driving policy rate expectations higher throughout the developed world, and generating more volatility in major currency pairs.

The pound is holding near a 14-month low against the dollar as markets take an increasingly skeptical view on the Labour government’s fiscal plans, with higher gilt yields expected to force a pullback in growth-positive spending initiatives. We think this is overblown, given that—in percentage change terms*—the move up in British yields has been relatively tame in comparison with other countries, but with technical conditions deteriorating, a push lower is certainly possible.

China’s yuan is stabilising after authorities took a harder line on intervention over the weekend, suggesting that widespread expectations for a gradual depreciation this year could come to naught. In a series of steps taken over the weekend, the People’s Bank of China fixed the exchange rate well above market estimates, announced measures to reduce offshore liquidity, raised the amount onshore firms could borrow from overseas, and issued a statement saying it would manage foreign exchange markets more closely. Reports have suggested that state-owned banks have joined the effort, reducing lending into offshore markets in an attempt to bolster the yuan.

China’s trade surplus hit record levels in 2024, up 21 percent from the year prior as domestic demand weakened, global consumption kept growing, and US firms began front-loading imports. According to data released by the customs agency last night, the total surplus expanded to $992 billion dollars on a full-year basis in December. Although its share of China’s total exports continued to shrink, the country’s surplus against the US grew 6.9 percent to hit a total $361 billion—and was likely significantly larger, given undercounting of transshipment flows via other intermediary countries—despite repeated efforts by US administrations to address the imbalance.

And the countdown is on. With Donald Trump set to take office in just eight days, financial markets will remain in a state of heightened alert and episodes of volatility are likely as participants keep a weather eye on the incoming president’s Truth Social account. Major unknowns remain around the new administration’s trade and economic priorities, and economic policy uncertainty is likely to stay high for months, if not years. This backdrop favours the dollar, given the rest of the world's sensitivity to changes in US demand.

*This is, admittedly, an unconventional way to look at it, and isn't likely shared by many market participants.

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