Sterling's Resilience Faces A Setback

Sterling's outperformance faces challenges

Yesterday’s sharp sell-off in Sterling appears to have been driven by the global bond market sell-off, which struck a sensitive chord in the gilt market. This led to a widening of gilt spreads, prompting investors to reduce their overweight positions in Sterling.

For GBP, the key takeaway is positioning. Investors had viewed Sterling as one of the currencies most resilient to the broader strong Dollar trend. However, the gilt sell-off has shaken confidence in Sterling, increasing the risk of a reduction in Sterling long positions as investors reassess its perceived resilience.

It's also worth highlighting that strong local factors are not seen to be driving an extended gilt sell-off. However, modest downside risks for Sterling have now emerged.

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Tighter rate spreads overshadowed by tariff concerns

EUR/USD remains under pressure as firm US rates, rising Treasury yields, and lingering US tariff threats weigh on sentiment. While two-year EUR:USD swap rate differentials are narrowing slightly in favor of EUR/USD, this week has demonstrated that any gains for the pair can be swiftly erased by developments in the US trade narrative.

German industrial production for November came in slightly better than expected, but this is unlikely to have a meaningful impact on EUR/USD. Similarly, any rebound in Eurozone November retail sales (due at 10 GMT) is not expected to provide much support.

Expect further consolidation in EUR/USD during what is likely to be a quieter trading session. The range is likely to hold between $1.0290 and $1.0330.

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Quieter bond markets may bring stability

The first three trading days of the week were eventful: Monday saw sharp FX swings on US tariff speculation, Tuesday featured Trump’s expansionist policy and tariff threats, and Wednesday’s Treasury sell-off, driven by weak auctions, sparked broader market volatility, shaking out long sterling positions.

Some calm is expected today, with a better-than-expected 30-year US Treasury auction last night and a quiet bond market due to a federal holiday for the late President Jimmy Carter.

However, the Dollar is unlikely to lose recent gains. December FOMC minutes confirmed the Fed’s cautious approach to easing, with markets pricing a pause at the 29 January meeting and no 25bp cut until June. Five Fed speakers are set to speak today, but the next major driver will be tomorrow's December NFP report, with potential upside risks.

The Dollar remains supported ahead of Trump’s 20 January inauguration, where aggressive policy announcements are likely. Japan’s firm wage data adds to the case for a BoJ rate hike on 24 January, with USD/JPY expected to stay below the ￥158.00/￥160.00 range.

DXY has held support under 108 this week. Expect tight ranges today, with significant moves hinging on tomorrow’s payrolls—unless Trump makes headlines on Truth Social.

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