FX Markets 2025: Dollar Gains Momentum.

• USD Strength in 2025: The dollar is set to benefit from favorable seasonality in January and February, bolstered by optimism over Trump’s policies, with the DXY targeting 110.0. A reversal would require significant economic weakness or policy shifts, neither of which are expected imminently.
• Eurozone Pressures: EUR/USD trades 2.5% below fair value amid eurozone growth concerns, rising gas prices, and diverging central bank policies. A further decline toward 1.0200 remains likely before any potential recovery.
• GBP Limited by Fed and BoE Dynamics: While GBP/USD shows modest recovery, gains are constrained by the Fed’s cautious rate cuts and expectations of BoE dovishness, with markets pricing a 60-bps rate reduction for 2025.
• US Data in Focus: Key upcoming indicators include December’s labor market report (150k jobs expected, 4.2% unemployment) and ISM manufacturing data, which could influence Fed policy and dollar movement.
• Broader Macro Risks: European FX faces headwinds from weak growth and rising gas prices, while Trump’s protectionist stance and fiscal policies provide solid support for the dollar, barring unexpected policy shifts.

USD: Riding Seasonal Strength

As we kick off 2025, here’s a recap of our core FX views: we expect Trump’s policy mix to further strengthen the dollar, while European currencies, particularly the euro, face headwinds from protectionist policies and monetary easing. Emerging market currencies are also likely to struggle, as outlined in December’s FX Talking.

Historically, January and February are strong months for the dollar. Notably, December 2024 saw a surprising 2.6% rise in the DXY, defying a seven-year losing streak for the month, driven by optimism about Trump’s economic policies. With seasonality now in favor of the dollar, any reversal would need a strong counter-narrative, potentially from economic data. While a rapid labor market decline seems unlikely, gradual deterioration might keep the Fed cautious on rate cuts. A January rate cut would require a significant economic downturn, which is not our base case following the Fed’s hawkish December outlook.

As for Trump, his policy tone remains pivotal. Unless he unexpectedly softens on protectionism or fiscal stimulus, the dollar is likely to hold firm. The risk of a “Plaza Accord 2.0” to weaken the dollar seems minimal, and Trump may instead leverage FX policy for trade negotiations with partners.

On the data front, US jobless claims ended 2024 lower than expected at 211k, while December’s ISM manufacturing index is due today. With most recent prints in contraction territory, today’s release will test the optimism from November’s better-than-expected 48.4 figure.

Despite the year-end Treasury rally, the dollar remains poised for strong support. Growth concerns and rising gas prices continue to weigh on European FX, making the DXY target of 110.0 achievable.

EUR: Challenges Keep Mounting

The euro’s decline against the dollar in late 2024 was driven by diverging policy paths between the Federal Reserve and the European Central Bank. Even a narrowing in the EUR:USD two-year swap rate differential hasn’t helped the euro regain ground.

EUR/USD currently trades about 2.5% below its short-term fair value, reflecting concerns over eurozone growth and rising TTF gas prices (50 EUR/MWh) linked to Ukraine’s pipeline shutdown. With the euro’s broader outlook unattractive, another drop toward 1.0200 remains possible before any meaningful recovery.

GBP: Limited Upside Amid Fed’s Cautious Cuts

GBP/USD showed signs of recovery near 1.2440 early Monday, but gains are capped by the Fed’s hawkish tone. Investors await Fed Governor Lisa Cook’s speech for insights into rate cuts, which have slowed since September 2024.

The US labor market report on Friday will be crucial. Expectations include 150,000 new jobs in December and steady unemployment at 4.2%. Weaker data could weigh on the dollar, benefiting GBP. However, dovish expectations for the Bank of England (BoE)—with markets pricing a 60-bps rate cut in 2025—could pressure the pound. BoE policymakers remain divided amid weak consumer demand and inflationary risks tied to Trump’s tariffs and the UK’s Autumn Budget.