The financial markets stand on the edge of significant shifts as the week progresses, with the inauguration of US president-elect Donald Trump and an impending decision by the Bank of Japan (BoJ) setting the stage for potential volatility. The dollar has recently gained strength, and Treasury yields have surged amid growing expectations that the Federal Reserve may need to exercise caution in its approach to rate cuts this year. Meanwhile, investors are keenly awaiting Trump’s inauguration speech, seeking insights into his policy directions. The backdrop of tax cuts and the future of the Federal Reserve looms large as these events unfold.
The inauguration, scheduled for Thursday, is expected to set the tone for Trump's economic policies. Investors are particularly interested in any indications regarding tax cuts and fiscal stimulus plans. The speech comes at a time when implied volatility in one-week expiry FX options has been rising, suggesting that markets are bracing for potential swings. Even with Monday’s inauguration factored into calculations, this trend of increasing volatility persists.
In parallel, the BoJ kicks off the first round of central bank decisions for 2025 on Friday. The meeting, beginning on Monday, is poised to capture attention as Trump's virtual speech takes place. Recent summaries from December's gathering indicate that a rate hike might be imminent, contrary to prior expectations following Governor Ueda's press conference. However, the yen’s recent decline presents a challenge as further drops could prompt intervention by Japanese authorities.
The European Central Bank (ECB) and the Bank of England (BoE) are on track to cut interest rates more aggressively than the Fed this year. This divergence in monetary policy could be further emphasized if Purchasing Managers' Indexes (PMIs) continue to signal economic troubles for the Eurozone and UK. Such developments may widen the policy gap between these central banks and the Fed.
In Canada, investors are closely monitoring for a potential rate cut by the Bank of Canada (BoC) on January 29. A 65% probability is currently assigned to a 25 basis points cut; however, stronger-than-expected Consumer Price Index (CPI) figures could alter this outlook. Additionally, wage growth accelerated in November, adding another layer of complexity to the BoC’s decision-making process.
The release of the US S&P Global PMIs on the same day as Trump’s inauguration adds another variable to watch. Dollar traders will be parsing these figures while simultaneously digesting any policy signals from Trump’s speech. The anticipation is palpable, with markets eager to gauge the new administration’s stance on tariffs and other critical economic issues.