At this stage last year, we were talking about how the Fed might cut rates by around six times in 2024. This time around, we’re talking about how they might not even get to two rate cuts in 2025. As thing stand, traders are pricing in just ~36 bps of rate cuts for next year as seen here.

And among those central banks that are slated to continue cutting interest rates, the Fed is the one that market players are seeing with the highest probability of cutting the least. How the times have changed.

The dollar long con looks to be brought forward. But what has changed?

The biggest thing of course is the US election result. Trump’s win has definitely altered the landscape with threats of large scale tariffs against US trade partners and tax cuts. That has thrown a spanner in the works of the Fed, who are still hoping to get inflation back towards 2%.

The disinflation process has proven to be a bit bumpy also as of late, albeit still largely running its course. However, the muddied outlook now makes it tough to envisage a smooth and clear path back towards the 2% target. Not least with the US consumer still running hot, despite a softening labour market.

So, the real risk for the dollar now ties back to the economy and how Trump’s policies might impact all of that. The outlook now hinges on the notion that Trump will eventually get his way in executing his campaign pledges. And that’s reflected in the more hawkish Fed pricing by markets and arguably also among policymakers at the latest FOMC meeting.

As such, the reaction function suggests that any tail risk that materially leads to a different scenario other than that will be bad for the dollar. That being these few couple of situations:

1. The economy turns out to be much softer in 2025, with labour market slack gathering pace
2. The disinflation process stays the course and resumes a quicker pace again in the new year
3. Trump tariffs are not as forceful and high octane as anticipated, leading to less inflation fears
4. Trump tax cuts hit a bit of a snag and gives markets more time to digest the whole situation

I would argue that right now, emotions are still running high particularly after the latest Fed policy decision. The dot plots and Powell’s remarks suggest a pause in January, which might extend further depending on economic developments.

That’s giving the dollar a tailwind going into the turn of the year. But as we saw with how things played out this year, this sort of tailwind can eventually dissipate and turn the other way around. At some point in the middle of 2024, we were talking about just one rate cut by the Fed for the year as opposed to the six priced in during December 2023.

So, that is pretty much where we’re at. It’s a case of markets having a rough idea of what may transpire in 2025 but nothing is a given. In trading, the journey is just as important as the destination at the end of the day.

This article was written by Justin Low at www.forexlive.com.

• China’s MIIT predicts a 5.7% y/y growth in industrial output for the January to December
• China’s industrial profits decline four straight months, but at a slower rate
• Japan finance minister Kato – alarmed by FX moves, driven by speculators
• South Korea says it has a North Korean soldier in custody
• China November Industrial profit Year to Date (YTD) -4.7% y/y (prior -4.3%)
• PBOC sets USD/ CNY reference rate for today at 7.1893 (vs. estimate at 7.2981)
• Japan inflation data and BoJ December summary raise expectations of a January rate hike
• BoJ December 2024 Summary of Opinions – ‚Gradual increase in CPI‘
• Japan Retail sales for November: +2.8% y/y (expected +1.6%)
• Japan Industrial Production for November (preliminary): -2.3% m/m (expected -3.4%)
• Japan data: October Unemployment rate 2.5% (expected 2.5%)
• Tokyo area December inflation data: Headline 3.0% y/y (expected 2.9%)
• Catch up – OPEC+ does not have „the bandwidth to prop prices much higher“
• Catch up – World Bank raised its 2024 China growth forecast to 4.9%, from 4.8% previously
• Catch up – Further supportive measures in store for China housing sector in 2025
• Catch up – China revises up 2023 GDP by 2.7% from previous estimate
• Trade ideas thread Friday, 27 December, 2024, insightful charts, technical analysis, ideas

In
US time on Thursday USD/JPY traded to circa 158.09,
its
highest
since mid-July this
year. The pair pulled back toward 157.50 during the session here,
responding to:

• December
  inflation
  in Tokyo accelerated for a second month, the government temporarily
  phased out utility subsidies;
• the
  ‘Summary of opinions’ from the Bank of Japan December meeting
  (when the bank maintained its policy rate at 0.25%) showed the policy
  board members remaining optimistic in its assessment that the
  economy and inflation are moving in line with its projections –
  amidst caveats of course – supporting market expectations for a
  near-term rate hike, perhaps as soon as the January 23-24, 2025 meeting.

JPY
crosses slid also. EUR/JPY’s slide was cushioned somewhat by a
drift down a few points for EUR/USD. There were no fresh notable news items for the euro.

From
China
today
we had data showing that industrial
profits extended
their
decline to a fourth straight month, dropping 7.3%. The
flip side, if you prefer a brighter take, is that the fall was slower than the
10% drop in October. The YTD figure worsened, to -4.7% in
January-November from -4.3% in the January-October period.

Regional equities rose, following a lead from higher Wall Street.

This article was written by Eamonn Sheridan at www.forexlive.com.