Foreign Exchange Commentary

Summary

• U.S. inflation edgers lower.
• Market re-adjusts expectations of Federal Reserve Bank interest rate moves.
• U.S. Dollar rally stalls.
• Japan might be poised to raise interest rates on January 24.
• Canadian political landscape shifts with former central banker Mark Carney entering the race for Prime Minister.

U.S. Inflation Cools
After last Friday’s strong U.S. employment report, financial markets took off the table the number of Federal Reserve Bank interest rate cuts in 2025. Some economists and market pundits even mentioned the possibility of interest rate hikes later this year. That helped the U.S. dollar make new highs against the major currencies last Friday.

This week’s U.S. inflation data changed that picture. On Wednesday, the U.S. Producer Price Index came out up 0.2% vs. market expectation of 0.4%. The reaction in the market was muted but upward momentum in the U.S. dollar rally slowed. On Thursday, U.S. Consumer Price Index (ex-food & energy) came out at up 0.2% vs which was weaker than market expectations around 0.3% and lower than last month at 0.4%. On an annualized basis, inflation by this measure sits at 3.2%.

The market’s reaction was favorable as these data points show that U.S. inflation could still be on its downward path towards the Federal Reserve Bank’s 2.0% inflation target. As a result, the U.S. dollar has edged lower since last Friday around 1.25%. Likewise, U.S. Treasury bond yields moved lower and equity markets moved higher.

New York Federal Reserve President John Williams said “the process of disinflation remains in train. But we are still not at our 2.0% goal, and it will take more time until we can achieve that on a sustained basis.”

As things sit now, through the end of 2025, Fed Funds Futures has U.S. interest rates coming down 0.25% to 4.25%. At the same time, the markets have the central banks of Canada, Euro-zone, U.K., and Australia suggest more aggressive interest cuts as the view of their economies are not as optimistic as the United States.

Japanese Interest Rate Hike?
While most of Europe and North America are set for some degree of lower interest rates, Japan is the exception. Coming into Q4 2024, the market vacillated between the Bank of Japan (BOJ) raising rates and then not doing so. Now, it seems the timing might be right at the January 24^th BOJ meeting.  On Tuesday, BOJ Deputy Governor Himino hinted of a 0.25% rate hiking citing the momentum of domestic wage growth and possibly stronger than expected U.S. economy. Taro Kimura with Bloomberg Economics pointed out that Trump’s inauguration address on January 20^th is before the BOJ meeting. With that, he observed that if Trump does not deliver a big negative surprise, this could encourage the BOJ to raise interest rates.

Canadian Political Landscape
With the resignation of Canadian Prime Minister Justin Trudeau, the race of the new Prime Minister got interesting on Thursday when former central banker Mark Carney announced that he is going to run for the office. Mark Carney is not your typical politician. As the head of the central bank of Canada, he helped navigate the Canadian economy through the Great Financial Crisis. Then, he led the central bank of England during Brexit. In other words, he has extraordinary experience in international economics. In his comments announcing his candidacy, “I’m not the only Liberal in Canada who believes that the Prime Minister and his team let their attention wander from the economy too often. I will not lose focus.”  The combination of Trump’s tariff threats along with Carney’s desire to ascend to the top spot in Canada could result in very interesting economic and political posturing.