Market Brief: Bond Market Turmoil Eases, Dollar Edges Lower

A multi-day selloff in global bond markets appears to be easing, providing some support to currencies outside the United States. The US ten-year yield is holding near 4.65 percent this morning after breaking through 4.72 percent in yesterday’s session, and rates are easing across most major economies, helping the euro, yen, and Canadian dollar stabilise against the dollar.

A series of better-than-expected economic data releases—paired with growing fears surrounding the incoming Trump administration's impact on inflation—have lifted US yields in recent weeks, widening cross-currency rate differentials even as global borrowing costs have moved higher. With the economy performing well, underlying price pressures proving stubbornly strong, and tariff threats driving a front-running process among American corporates, expectations for rate cuts from the Federal Reserve have been pulled dramatically lower, with market participants now expecting just a single move over the coming two years.

Yesterday’s meeting minutes didn’t provide any relief. “Almost all” members of the Fed’s rate-setting committee “judged that upside risks to the inflation outlook had increased,” according to a record of the December 17-18 session. “Participants expected that inflation would continue to move toward 2 percent, although they noted that recent higher-than-expected readings on inflation, and the effects of potential changes in trade and immigration policy, suggested that the process could take longer than previously anticipated”, the minutes said. “Given the elevated uncertainty regarding specifics about the scope and timing of potential changes to trade, immigration, fiscal, and regulatory policies and their potential effects on the economy, the staff highlighted the difficulty of selecting and assessing the importance of such factors for the baseline projection and featured a number of alternative scenarios.”

Equity markets will be closed in the United States today and bond markets will shut early for observance of former President Jimmy Carter’s funeral, but tomorrow’s non-farm payrolls report looms as the next potential catalyst for market-moving shifts in policy expectations. Although there is abundant evidence of a longer-term moderation in labour markets, and economists expect a relatively-modest monthly job-creation number around the 160,000 level, other high-frequency data points would suggest that the post-hurricane rebound could continue into a third month. A print that surprises to the upside could send yields and the dollar higher once more.

Moves in British financial markets are drawing uncomfortable comparisons with the budget debacle that ended Liz Truss’s brief stint as prime minister. To our knowledge, no one is yet live-streaming the deterioration of a lettuce, but a simultaneous sell-off in fixed income and foreign exchange markets—something more typical of emerging market crises—has seen the government’s 10-year borrowing costs rise to the highest levels since the global financial crisis even as the pound has fallen to a two-year low. It’s difficult to quantify the reasons behind this idiosyncratically-extreme reaction to the turmoil currently unfolding in global bond markets, but we think the country’s unique vulnerabilities—a stagflationary economic outlook and negative balance of payments—have exacerbated the move. The United Kingdom ran the second-largest current account deficit, as a percentage of gross domestic product, among G7 countries in 2024, but without the privileges which accrue to the country with the largest deficit: the United States. Being the global hegemon has its privileges.

On the other side of the planet, the Chinese renminbi is trading near a 16-month low as authorities grapple with the opposite sort of inflation problem: prices that are flirting with a push into negative territory. According to data published last night, Chinese consumer prices rose just 0.1 percent in December from a year earlier, with soft property markets and poor employment prospects weighing on household spending levels. Consumer confidence remains incredibly weak after a raft of half-hearted stimulus announcements from authorities, and hopes for an improvement seem unrealistic in the absence of an exogenous shock from the White House. Perhaps counter-intuitively, an imposition of tariffs by the incoming US president could strengthen China by forcing policymakers into a more aggressive internal rebalancing process.

The Mexican peso is coming under modest selling pressure after the national statistics agency said inflation fell to a three-year low in December, helping bolster odds on a fifth consecutive rate cut at the central bank’s next meeting. Consumer prices climbed 4.21 percent on a year-over-year basis while a core measure—which excludes highly-volatile food and energy categories—accelerated slightly to 3.65 percent, remaining only slightly above the country’s official 3-percent inflation target. Officials are widely expected to cut the benchmark cash rate to 9.75 percent on February 6, reducing the extent to which high borrowing costs restrict economic growth, while also maintaining a wide buffer in real terms over US Treasuries. This could be needed to keep the exchange rate supported in the event that Donald Trump follows through on campaign trail promises to impose significant tariffs on Mexico.

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