High beta FX outperforms as geopolitical risks ease

AUD: Diminished risk of trade war & stronger labour market provide support

The Australian dollar has been the best performing G10 currency overnight extending its outperformance at the start of this year. The Australian’s dollar’s upward momentum has been reinforced by the release of stronger than expected domestic labour market data, and the broader improvement in global investor risk sentiment after President Trump dropped his threat to use military action to take control of Greenland and/or impose tariffs on imports from fellow NATO countries including the Germany, France and the UK. The positive development came after a meeting between President Trump and NATO Secretary General Mark Rutte at the World Economic Forum in Davos. President Trump has expressed optimism over a “framework of a future deal” although it remains unclear that agreement could entail. However, it was sufficient to prompt President Trump to post “the solution, if consummated, will be a great one for the United States of America, and all NATO Nations. Based on this understanding, I will not be imposing the Tariffs that were scheduled to go into effect on 1^st February”. He previously threatened to impose a 10% tariff from 1^st February which could rise up to 25% from 1^st June if an agreement was not reached to control or purchase Greenland.

Market participants have expressed initial relief that the threat of US military action or tariffs is off the table at least for now, although will remain wary that they could return if talks don’t progress as President Trump desires in the coming weeks and months. Avoiding a tit for tat trade war is a positive development for the global growth outlook and supports our outlook for stronger growth this year. Commodity currencies such as the Australian dollar and Latam FX have already outperformed at the start of this year in anticipation of stronger global growth and rising commodity prices.       

At the same time, the Australian dollar has been boosted overnight by the hawkish repricing of RBA policy expectations. The 2-year Australian government bond yield has jumped higher by around 9bps following the release of the latest labour market report from Australia. The report revealed that employment increased strongly by 65.2k in December, which was the strongest monthly increase since April of last year. Stronger employment growth helped to lower the unemployment rate by 0.2 percentage point to 4.1%. After peaking at 4.4% in September, the unemployment has almost fully reversed the move higher in the first nine months of last year. A development that will add to the RBA’s concerns over the risk of more persistent inflation in Australia stemming from the tight labour market. The RBA had been forecasting an unemployment rate of 4.4% in Q4. The tighter labour market has further reinforced expectations that the RBA will begin hiking rates at the start of this year. A rate hike is now judged as more likely than not (~15bps priced in) to be delivered by the next policy meeting in February, and is more than fully priced (~32bps) by May. The combination of rising commodity prices and widening yield spreads in favour of Australia support our long AUD/GBP trade recommendation (click here).

LONG AUD IS A POPULAR POSITION AT START OF 2026

Source: Bloomberg, Macrobond & MUFG GMR

USD: Trump‘s quick u-turn & Supreme Court hearing dampen downside risks

The US dollar has rebounded modestly against other major currencies after President Trump dropped his threats of military action and/or imposing tariffs on fellow NATO members. Heightened US policy uncertainty under the Trump administration relating to foreign policy, trade policy and interference with Fed’s independence has contributed to a weaker US dollar over the past year. The loss of confidence in US policymaking is likely to remain a headwind for the US dollar as we have seen at the start of this year. However the risk of a sharper US dollar sell-off have diminished after President Trump’s quick climb down over Greenland, and early indications from the Supreme Court overnight that they are likely to rule against President Trump’s decision to fire Fed Governor Lisa Cook. The Financial Times has reported that the US Supreme Court justices appeared sceptical of Donald Trump’s efforts to sack Governor Cook. Several justices appeared wary of solicitor John Sauer’s arguments that the courts should not have reinstated Governor Cook and that President Trump has the power to fire her without due process. Justice Brett Kavanaugh warned that firing a Fed Governor with no judicial review or process could “weaken if not shatter” the Fed’s independence.              

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com