Tariffs, Jobs Data, and Central Bank Signals.

• USD: Markets remain hopeful for a US-China trade deal, but risks are underappreciated. Economic data shows a cooling labor market.
• EUR: Limited upside potential for EUR/USD, with trade risks and unattractive fundamentals keeping gains in check.
• JPY: Strong wage growth in Japan reinforces expectations for rate hikes, supporting the yen.
• GBP: The BoE is set to cut rates, but with expectations largely priced in, downside risks for GBP are limited.
• Market Themes: Trade tensions, central bank decisions, and economic data remain key drivers for FX markets.

USD: Trade Uncertainty Keeps Markets on Edge

The dollar continues to slide following the US-Mexico-Canada border deal, shifting investor focus to China. With Beijing’s response to US tariffs appearing measured, markets remain hopeful for a resolution before China’s retaliatory tariffs take effect on January 10. The AUD/USD, a key indicator of sentiment towards China, has erased its previous risk discount, signaling optimism.

Despite this, markets may be underestimating the risk of prolonged trade tensions. Unlike tariffs on Canada and Mexico, those on China have a lesser impact on US consumers and producers, allowing President Trump more time to negotiate. His apparent lack of urgency to engage with President Xi Jinping suggests uncertainty remains. This puts pressure on AUD and NZD, which are currently pricing in a deal.

Meanwhile, reports of Trump’s alleged intent to take over Gaza and relocate Palestinians have been met with skepticism. However, any indication of US troop deployment in the Middle East could trigger a risk-off market reaction, pushing oil and the dollar higher.

US economic data is also in focus, with job market figures showing some weakness. The JOLTS report pointed to a cooling labor market, with the quit rate—a key wage growth indicator—holding steady at around 2%, suggesting stable private sector wage growth of 3% YoY. Today’s ADP employment data and ISM services survey could influence market sentiment, with particular attention on the inflation-sensitive price paid subindex.

For now, the dollar may see further downside on optimism around a US-China deal, but lingering trade tensions should prevent a prolonged decline.

EUR: Limited Upside as Fundamentals Weigh on the Euro

EUR/USD remains capped as it nears 1.040, with macroeconomic fundamentals offering little support. Trump’s previous tariff threats against the EU add to downside risks, reflected in a two-year swap rate gap of -185 basis points, discouraging a stronger euro.

With a quiet eurozone economic calendar, trade headlines will dictate EUR/USD movements. Inflation data slightly exceeded expectations, but any policy shift from the ECB remains uncertain. Chief Economist Philip Lane’s comments today may offer some insight.

Elsewhere, EUR/JPY could see further downside, as strong Japanese wage growth (4.8% YoY in December) strengthens the case for two Bank of Japan rate hikes this year, supporting the yen.

GBP: Bank of England Rate Cut Looms

With the Bank of England’s policy decision approaching, GBP volatility is expected. Markets anticipate another rate cut, with hints of further easing in response to slowing economic growth and rising unemployment.

Traders are now pricing in up to four rate cuts in 2025, up from the previous expectation of three. This could weigh on UK bond yields and the pound. However, the currency has already weakened significantly against major peers in early 2025, reflecting the UK’s economic slowdown.

As a result, any additional GBP weakness following the BoE decision may be short-lived, as the market has largely priced in further rate cuts.