Dollar Stumbles, Euro Awaits PMIs, and Pound Rallies on Strong Data.

• Dollar correction: The USD weakened sharply as traders repositioned due to soft US data, underperforming equities, and cautious optimism over US-China trade talks.
• Economic concerns: Weak Walmart earnings and declining consumer sentiment suggest the late-2024 economic optimism may have been premature.
• Fed vs. market expectations: While markets anticipate rate cuts, the Fed remains hawkish due to inflation concerns, creating uncertainty around USD movements.
• Euro outlook: The EUR gained from USD weakness but remains unattractive overall. Attention turns to today’s PMI data and Germany’s election on Sunday.
• Pound strength: Strong UK retail sales and tax receipts boosted GBP, pushing GBP/USD to a two-month high and GBP/EUR to firm levels.

USD: A Market Shake-Up on Souring US Sentiment

FX markets saw intense volatility yesterday, with the US dollar surrendering its weekly gains as traders repositioned in response to shifting market dynamics. A combination of factors fueled this dollar correction: US President Donald Trump’s comments hinted at a potential trade deal with China, economic data came in weaker than expected, US equities stumbled after disappointing Walmart earnings, and the Treasury yield curve flattened following remarks by Treasury Secretary Scott Bessent.

While hopes of a US-China trade breakthrough might seem like the biggest driver for FX markets, investors are treating Trump’s statements on trade with more caution. Today, Bessent is set to hold his first call with Chinese officials, and while prior engagement with trade partners has yielded some constructive dialogue, negotiations with China are expected to be more complex than the swift agreements made with Canada and Mexico. Tariffs remain a key component of the US strategy to address the trade deficit, suggesting a drawn-out negotiation process with potential market turbulence.

We don’t see the dollar’s decline as purely a reaction to upbeat trade talk. Instead, it reflects a deterioration in US economic sentiment. Walmart’s lackluster earnings highlighted weaker consumer spending, even before factoring in tariffs, and recent data suggests that the late-2024 economic optimism may have been short-lived. January’s US Consumer Board Leading Index resumed its downward trend, following a surprise retail sales drop.

At this stage, FX markets appear to be reacting more proactively than interest rates. Short-term USD swap rates have edged lower, but markets remain hesitant to fully price in two Federal Reserve rate cuts this year due to the Fed’s hawkish stance. Policymakers seem more concerned about Trump’s inflationary policies than sluggish growth, as reflected in this week’s Fed minutes.

While we don’t expect a sustained downtrend for the dollar, the bar for a negative reaction to weak data is relatively low. The road to dollar strength could be uneven, but ultimately, we anticipate the focus will shift back to tariffs—overshadowing optimism about a potential Russia-Ukraine peace deal and reassessments of US growth. Overall, we see upside risks for the dollar moving forward.

EUR: PMIs Take Center Stage

The euro has benefited from traders unwinding long dollar positions, but remains unappealing in most currency crosses. Today’s PMI release will be key in determining whether the euro can find some independent strength. However, our economists are not optimistic about a sharp rebound in eurozone growth, with the composite PMI expected to edge up only slightly from 50.2 to 50.5.

German data will be under particular scrutiny after the latest ZEW survey showed improved investor sentiment ahead of the country’s elections. Expectations for German PMIs remain modest, with only a slight uptick projected.

The major event for the euro is Sunday’s German election. Polls indicate CDU/CSU leading at around 30%, followed by the far-right AfD at 20% and the outgoing SPD at 15%. Markets are not overly concerned about a stronger AfD result, as mainstream parties have committed to keeping the far right out of any coalition. However, some traders may look to close EUR/USD positions at these higher levels ahead of the election risk. Our outlook remains bearish on EUR/USD.

GBP: Retail Sales Boost the Pound

The pound gained ground against both the euro and the dollar after strong UK economic data eased concerns about the country’s growth trajectory.

The GBP/USD exchange rate reached fresh two-month highs just below 1.2680, while GBP/EUR held steady around 1.2075.

UK retail sales volumes surged 1.7% in January, rebounding from December’s revised 0.6% decline and far exceeding consensus forecasts of a 0.4% increase—the highest figure since August 2024. Food-store sales saw a strong 5.6% increase, although non-food store sales declined.

While sales volumes fell 0.6% in the three months to January compared to the previous quarter, they were up 1.4% year-on-year. Additionally, UK consumer confidence improved slightly, with the GfK index rising to -20 in February from -22, beating market expectations.

Provisional data showed the UK government recorded a budget surplus of £15.4bn in January, up from £14.6bn the previous year—the largest January surplus since records began in 1993.