Dollar’s Resurgence: Room to Run?.

• The US dollar’s rally continues, supported by geopolitical uncertainties and potential trade tariffs.
• Rising US Treasury yields and reduced correlation with equities bolster the dollar’s outlook.
• The euro faces headwinds due to geopolitical concerns and Trump’s stance on NATO allies.
• EUR/USD may weaken further, with a possible move toward 1.0400 this week.
• UK inflation data was largely ignored by markets, with steady declines in core services inflation reinforcing expectations for gradual rate cuts.

USD: Momentum Remains Strong
The US dollar extended its recovery yesterday, though early trading today has seen a slight shift in favor of the yen and Antipodean currencies. In the coming days, markets will closely monitor developments in Ukraine, particularly the potential for a ceasefire and its terms. So far, discussions between the US and Russia have excluded both Ukraine and the EU, raising concerns about Europe’s strategic and economic isolation. This dynamic could further drive demand for safe-haven currencies like the USD and JPY. Additionally, former President Trump’s suggestion of 25% tariffs on auto, pharmaceutical, and chip imports may add to the dollar’s appeal.

US Treasury underperformance has also played a role in the dollar’s strength, with 10-year yields rising to 4.55% and possibly testing 4.65%. Notably, the correlation between the S&P 500 and the Bloomberg Dollar Index has declined from -0.60 a month ago to -0.35, indicating that the dollar’s movement is less influenced by equities. Despite the S&P 500 reaching new highs, the dollar’s recovery remains intact.

The key macro event this week is the release of the FOMC minutes from the January 29 meeting. Markets have received clear signals from Fed Chair Powell that rate cuts are not imminent, with inflation concerns taking priority. Any hawkish reinforcement in the minutes could further bolster the dollar.

Despite the dollar’s recent gains, its valuation remains balanced rather than overstretched, suggesting continued upside potential in the near term.

EUR: Struggles Continue
The German ZEW index rose yesterday, likely reflecting investor optimism over a possible pro-market government shift. However, this hasn’t translated into real optimism about economic growth.

The euro’s performance remains closely tied to sentiment around US-Russia relations, with European currencies showing signs of relative underperformance. Trump’s transactional stance on NATO allies may further weaken the euro.

A short-term valuation model indicates that EUR/USD is not carrying a risk premium, implying more downside potential if markets price in greater US protectionist risks. A move toward 1.0400 this week remains a possibility.

GBP: Inflation Concerns Remain Modest
The release of January’s UK inflation data had little effect on the pound. Headline CPI rose to 3.0%, slightly above expectations, mainly due to an unexpected rise in food prices. Markets have largely dismissed this uptick.

Services inflation came in at 5.0%, slightly below forecasts. However, the December data had been artificially low due to mismeasured Christmas airfare prices. More importantly, core services inflation, excluding volatile elements like airfares and rents, has been gradually declining, now at 4.2% compared to 4.7% two months ago. This trend supports expectations of one rate cut per quarter throughout the year.

EUR/GBP fell below 0.8300 as the euro continued to struggle, potentially due to Europe’s geopolitical positioning. While further declines to 0.8200 are possible in the short term, long-term support could come from a dovish repricing of the UK yield curve, which might lend some strength to EUR/GBP.