Foreign Exchange Commentary

Summary

• U.S. CPI and PPI came in higher than expected with CPI reaching a 9-month high MoM of 0.5% vs. 0.3%. YoY inflation stands at 3%.
• Interest rate cut expectations were trimmed to 1-cut in December.
• Jobs data also came at 213,000 - below expectations of 216,000.
• The U.S. dollar index has retreated from its’ February high's and is currently trading at 106.67.
• All G10 currencies have gained against the USD this week.
• The U.K. had an unexpected expansion in GDP, causing the GBP to rally.
• The Canadian dollar strengthened 1.5% vs. USD on a less dovish stance by the Bank of Canada.

U.S. Economic Landscape: Trade Policy and Inflation
Uncertainty surrounding U.S. trade policy, inflation data, and labor market indicators have been the main driver of currency markets this week. The implementation of new tariff measures, coupled with higher-than-expected inflation readings are shifting monetary policy expectations and currency valuations.

This week, the U.S. Bureau of Labor Statistics published its inflation figures, which showed unexpectedly high readings, with the Consumer Price Index (CPI) reaching 0.5% month-over-month, exceeding market expectations of 0.3%. The year-over-year inflation rate stands at 3%, slightly above the forecasted 2.9%.

The Producer Price Index (PPI) data similarly exceeded expectations, recording 0.4% month-over-month against a projected 0.3%, with the year-over-year figure at 3.5%. This elevated producer-level inflation initially suggested potential downstream pressure on consumer prices and was initially taken by traders as a sign that inflation may remain elevated in the coming months. However, a deeper examination reveals that a substantial portion of the increase in PPI was attributed to temporary accommodation services, while producer inflation remained stable at 3.5%, matching December's revised figure.

Market expectations for monetary easing are now anchored at one or possibly no rate cut this year. During his congressional testimony this week, Federal Reserve Chairman Powell reemphasized the Fed’s stance on data-driven decision-making and highlighted the Fed's commitment to achieving its 2% inflation target without rushing to implement rate cuts.

On the labor market front, the U.S. Department of Labor published its employment report this week. Initial jobless claims came in at 213,000, below market expectations of 216,000, signaling continued robustness in employment conditions. This persistent labor market strength also aligns with the Federal Reserve's cautious approach to monetary policy.

The U.S. Dollar
The U.S. Dollar Index has retreated from its early February peak of 109.88, primarily responding to a more measured implementation of trade policies by the current U.S. administration. From the volatility perspective implied volatility for euro currency, British pound sterling, Canadian dollar, and Mexican peso has been decreasing indicating a lower perception of USD strength and associated volatility in the month ahead. FX option valuations align with a lower likelihood of USD gains and this USD price action reflects the market’s adjustment to the evolving trade narrative.

The UK Economy and the Pound
Sterling showed strength this week following unexpected positive GDP growth of 0.1%, triggering an approximate 1% rally, but the Bank of England's downward revision of its 2025 growth forecast to 0.7% suggests economic challenges ahead.

The Euro
The Euro also rallied this week, achieving a two-week high of 1.0507 and marking its longest positive streak this year. This appreciation was mainly supported by reduced trade tension concerns, but potential diplomatic progress in Ukraine also played a role in the euro’s rally. However, the divergence between Fed and ECB monetary policy stances will continue to be a key factor going forward. As of now, the ECB has three cuts priced in for the remaining 10 months of the year.

The Canadian dollar
The Canadian dollar has been one of the best performing currencies this week, strengthening 1.5%, and currently trading at 1.4157 per USD, rallying from a 22-year low of 1.455 on January 31^st, as the Bank of Canada assumed a less dovish stance. The BoC minutes emphasized concerns that uncertainty over potential US tariffs is expected to weigh on business investment and fuel inflation. This has forced the Canadian central bank to refrain from providing forward guidance on interest rates.

Going forward
The interplay between inflation pressures, monetary policy decisions, and geopolitical developments will likely continue to drive currency market dynamics. The Federal Reserve's data-dependent approach to monetary policy, combined with evolving trade policies and international diplomatic efforts, will remain key factors influencing market direction.

The German election on February 23rd will be closely followed by the FX market because the result will provide clues about a possible truce in Ukraine and economic reforms in Germany, which is currently in a recession and weighing down the euro.