Forex: Spotlight turns to senate confirmation of Scott Bessent

Today's FX market is tuned into another expected round of positive US activity data. Still, the spotlight is sharply focused on the Senate confirmation hearing for Scott Bessent, Trump’s nominee for US Treasury Secretary. If Bessent emphasizes the critical importance of the dollar’s global status to the US economy, the dollar may find bolstered support.

Still, there's a lingering risk that Bessent might suggest other countries' central banks should strengthen their currencies, mainly targeting Asian nations. This potential guidance could be part of a broader strategy to balance the global currency field. Such comments would likely stir significant reactions in the forex markets, but I think he will stay away from that perspective and prop up the dollar.

Global stock markets have soared in the last 24 hours, which is typically dollar-negative, riding the wave of optimism triggered by the U.S. core CPI for December, which unexpectedly dipped below forecasts. This milder inflation read led to a notable 10-basis-point drop in U.S. short-dated yields, sparking hopes among investors that inflationary pressures might be easing.

Yet, even with this glimmer of positive data, the persistent stickiness of headline and core inflation near 3% year-over-year injects a dose of skepticism about the Federal Reserve's room to maneuver on rate cuts within the year, keeping the dollar somewhat in demand. So, while global bond and stock markets have experienced some relief, there has been limited knock-on into G10 FX markets.

Still, there's a buzz around the trading floors that the sell-off in EUR/USD might have been overdone relative to rate differentials. However, this perspective is tempered by the belief that the current pricing is justified. The market anticipates the impact of what President Trump could impose, but only a half-shot has been priced in.

As we edge closer to the presidential inauguration, the window for straightforward gains from long dollar positions against the Euro seems to narrow. These positions have likely reaped the bulk of their rewards. Tonight's robust U.S. economic data or an assertively bullish dollar remark from Scott Bessent could temporarily press the EUR/USD lower, sparking a reactionary dip. However, with Monday's pivotal events just around the corner, I'd advise against pursuing this rally further. Instead, consider this an opportunity to scale back on those dollar longs if they show strength. It’s about strategically locking in profits and maintaining flexibility, not doubling down on the rally's tail end. The markets are bracing for volatility; staying nimble will be key to navigating the unfolding economic narratives.

The prospect of a Bank of Japan rate hike next week is gaining attention, driven by recent reports from Bloomberg. This potential policy shift hinges significantly on the early actions of President-elect Donald Trump. If Trump’s initial policies disrupt financial markets or dampen the outlook for the U.S. economy, it could influence the BoJ's decision. The yen has shown volatility in response, with USDJPY dipping to 155.21 during the Tokyo fix before rebounding to 156. As the situation unfolds, traders closely monitor which direction Trump will take—whether he'll prioritize deal-making or impose new tariffs, adding a layer of uncertainty to the market's expectations.

Reflecting on the latest economic dispatches—the vigorous Non-Farm Payrolls, the Beige Book insights, and recent inflation metrics—there's little nudging the Federal Reserve from its perch of caution. The data paints a picture of a robust fourth quarter, with consumer spending and economic growth hitting solid marks and employment stepping up. Despite the general steadiness in core prices, the looming shadows of new year tariffs inject a note of caution. Given these mixed signals, the Fed's current 'wait and see' stance rings especially prudent as we hover for clearer skies on tariffs and inflation's potential twists.

Why the massive “risk-on” rally?

In the last few weeks, the bond market has wielded a heavy hand over the equities sector, with a ballooning term premium reaching a decade-long peak and long-end yields soaring past 5%, hinting at a return to cycle highs. This yield surge left the stock market on edge, mainly as richly valued equities felt the pinch. The tension reached a fever pitch last week with a harsh bear flattener triggered by another strong U.S. jobs report, which led the markets to nearly abandon expectations for any Fed rate cuts in 2025.

However, the narrative sharply turned on Wednesday when even mildly dovish winds blew through the Fed's corridors. A surprisingly cooler core CPI report for the month showed the slowest rise in consumer prices since last summer, offering a glimmer of hope and gingerly resetting Fed expectations with one full rate cut priced in the latter part of the year and coin flip on a second. But certainly, the milder core CPI data delivers a crucial cushion for the Federal Reserve amidst the swirling uncertainties of impending tariffs. The complexity of the Fed's policy-making skyrockets with the composition, pace, and scope of these tariffs shrouded in ambiguity.