Forex market walks a tightrope

The EURO caught a bid this morning after Donald Trump revealed he had a “productive” 90-minute call with Vladimir Putin, discussing a potential ceasefire in Ukraine. The market reaction was swift—EUR/USD surged, risk appetite firmed, and crude oil took a hit. But let’s not get ahead of ourselves. The path forward is anything but clear, and with Trump’s next round of tariffs looming, this rally has some serious hurdles to overcome.

Under normal circumstances, this morning should have been all about the hotter-than-expected US inflation print. The data screamed higher rates for longer, pushing Treasury yields up and initially sending the dollar into overdrive. For a few hours, the market followed the script—USD rallied, risk assets wobbled, and everyone braced for Powell & Co. to stay hawkish for months to come.

Then, the narrative flipped on its head. News broke that Trump had spoken with Putin, laying the groundwork for a potential resolution to the Ukraine conflict. Suddenly, the market recalibrated. The White House’s stance appears to be that while the US is willing to broker a deal, it has no interest in peacekeeping—meaning Europe would shoulder the burden. Regardless, investors latched onto the positives: improved confidence in the region, reduced global energy supply risks, and a broad relief rally in European assets. Oil and European natural gas prices tanked, giving global growth expectations a boost and dampening inflation fears—yet another reason for traders to scale back their long-dollar bets.

Meanwhile, over in China, optimism is creeping back into the mix. The DeepSeek AI buzz continues to fuel speculative plays in tech, and expectations are building that Beijing could announce fresh economic support measures in early March. That’s helped USD/CNY dip back below 7.30, a key psychological level, as investors cautiously wade back into Chinese assets.

But here’s the catch—Trump’s tariff hammer is still swinging. The market is now on high alert for his next executive order, expected today. The key question: Will he laser-target the biggest tariff offenders, or will he go scorched-earth and hit everyone? The FX market is walking a tightrope, caught between hopes for a geopolitical breakthrough and the very real risk of a full-blown trade war.

Bottom line? The ceasefire talks are injecting some much-needed optimism, but the jury is still out. If Trump dials back the trade rhetoric, expect risk assets to keep pushing higher. But if tariffs take center stage again, the dollar could rip higher, and we’re right back to risk-off mode. One thing is for sure—volatility isn’t going anywhere.

A CPI overraction?

Inflation isn’t dead—not by a long shot. Of course we all knew that and January’s US consumer price index print merely reinforced what has been clear for months. Yet, markets reacted as if a grenade had been thrown into rate-cut expectations. But should they have been so shocked?

The biggest ripple effect came in inflation breakevens—the market’s built-in forecasts for future inflation based on the gap between fixed and inflation-linked bond yields. The two-year breakeven shot past 3%, the highest in two years and above the Fed’s upper comfort range. The 10-year breakeven also climbed to a two-year high at 2.5%, flashing a clear sign that markets are growing jittery about inflation’s persistence; the broader message is clear: inflation anxiety isn’t going away anytime soon.

For the Federal Reserve, this all but cements a "wait-and-see" approach, delaying rate cuts until much later this year. And beyond monetary policy, the bond market’s inflationary jitters should be a wake-up call on the trade front. Tariffs are inherently inflationary in the short term, and Trump’s looming reciprocal tariffs could add another layer of uncertainty.

That said, the raw inflation numbers aren’t exactly an apocalypse. Headline inflation edged up from 2.9% to 3.0%, while core inflation (excluding food and fuel) rose from 3.1% to 3.3%. A closer look at the details reveals that the bump was largely driven by energy inflation flipping from negative to positive and a slightly softer decline in core goods prices. Meanwhile, services inflation—the main driver of price pressures—ticked down ever so slightly.

Bottom line? Inflation is still sticky, but the market’s reaction may have been overdone. However, with tariffs in play and bond markets sending warning signals, anyone betting on aggressive Fed cuts in 2025 might want to rethink their position.