FX Market Update: Politics Drive Volatility as USD Stumbles.

USD – Remains volatile after a sharp sell-off on trade-war fears, with sentiment now hinging on political rhetoric rather than data.

EUR – Gaining relative strength versus the dollar, supported by USD weakness and a calmer, more predictable ECB backdrop.

GBP – Underperforming peers as domestic data and global bond volatility weigh on sterling, keeping downside risks in focus.

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USD:

The US dollar sold off sharply yesterday as markets reacted to renewed fears of a potential US–EU trade war, alongside headlines around the possibility of Europe reducing its holdings of US Treasurys. While markets have steadied somewhat overnight and the dollar is marginally firmer this morning, confidence remains fragile.

Attention today is firmly on President Trump’s speech at Davos, particularly any escalation in rhetoric around trade policy and his ambitions regarding Greenland. There is some US home sales data due later, but the real data risk begins tomorrow with core PCE inflation, followed by PMI surveys on Friday. For now, political headlines rather than fundamentals are driving near-term dollar moves.

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EUR:

The euro enjoyed its strongest session against the dollar since September, benefiting directly from the broad USD sell-off. With US political uncertainty dominating, the euro is once again being viewed as a relative stabiliser rather than a high-conviction bullish story.

Today’s focus is split between Davos headlines and speeches from ECB President Lagarde and Bundesbank President Nagel, which may reinforce the ECB’s steady policy stance. While euro-area growth remains modest, the absence of immediate policy shocks leaves EURUSD biased to consolidate recent gains, provided US-driven volatility persists.

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GBP:

Sterling significantly underperformed yesterday. UK headline inflation accelerated to 3.4% in December, but this was offset by core inflation easing slightly to 3.2%, leaving Bank of England rate-cut expectations largely unchanged. More damaging for the pound was a soft labour market report and the gilt market’s sensitivity to global bond volatility.

Looking ahead, tomorrow’s PMI data will be watched closely, but markets are also increasingly focused on rising political tensions between Trump and Starmer, after the US President publicly criticised several UK policies. In the absence of a clear positive domestic catalyst, sterling remains vulnerable to further underperformance.

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