Reversion
A defining feature of 2024’s FX market has been the inversion of many Dollar-termed forward curves. Despite the rising cost of holding US Dollars against the base of such currency pairs, the Dollar has remained relatively well bid. However, for those currencies that have emerged with a positive carry versus the US Dollar, FX demand has generally increased. One currency that has benefitted from this historically rare phenomenon has been GBP. The re-election of Trump poses a significant threat to whether this residual FX tailwind can endure with some US yields forecast to face upward pressure.
The front end of the US yield curve is likely to still decline. Interest rate cuts are still what will characterise the Fed’s output over the year ahead which will command shorter dated yields lower. However, Trump’s re-election, including the announcement of a wave of intended tariffs, as we covered yesterday, creates inflationary risks. That inflationary risk will raise borrowing requirements in the US and therefore the required terminal rate of interest. Both of these factors will steepen the US yield curve. The impact of that steepening on FX forward curves will of course depend on that currency pair in question.
With regard to GBPUSD, what UK yields are expected to look like is currently far from clear. The fiscal output of the new government and its treasury so far have created confusion and concerns of excessive debt. If these risks are contained, we may well see a reversion in GBPUSD forwards higher once again. With the US curve expected to steepen, prior to this general rising of the tide we may first see an inverted curve where a few tenors break out from negative territory before others.
Discussion and Analysis by Charles Porter
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