Macroeconomics of the United States
Essential insights for US Dollar traders...
Friday, January 31, 2025, Week 05
The US political landscape is shifting dramatically under the newly inaugurated President Trump. His inauguration on January 20th injected a significant dose of uncertainty into the markets. It's a constitutional federal republic, of course, with the familiar three branches: Executive (President Trump), Legislative (Congress), and Judicial (Supreme Court). The Republicans control both houses of the 119th Congress. This should, in theory, make it easier for Trump to push his agenda through. However, with some internal divisions within the Republican party, and considering the current political climate, I anticipate some legislative battles ahead. This will undoubtedly continue to fuel market volatility.
Trump's first ten days haven't been quiet. His "America First" rhetoric is more than just words; it's translating into concrete policy decisions with real market impact. Tariff threats against China, the EU, Mexico, and Canada are creating a risk-off environment, and the USD is reaping the benefits as a safe haven. But how far will he go? The markets are on tenterhooks. His January 17th call with President Xi offered a brief moment of calm, but the underlying trade tensions haven't disappeared. Domestically, Trump's attempt to impound $3 trillion in funds is tied up in legal challenges, adding to the fiscal uncertainty. And let's not forget the executive orders: immigration, LGBTQ+ rights, DEI initiatives. These aren't just social issues; they have economic consequences that are still rippling through the market. Even the firings of inspectors general across various agencies have traders talking – it's a question of governance and transparency that can't be ignored.
US Economy
The US economy remains a global powerhouse, with a nominal GDP of $29.167 trillion in 2024 and projected growth of 2.8%. The service sector, at 80.2% of GDP, continues to be the engine, driven by tech giants like Apple, Microsoft, and Google, along with financial behemoths like Amazon and energy stalwarts like ExxonMobil. These companies are market movers, and their performance has a ripple effect across the globe. Key exports – aircraft, pharmaceuticals, semiconductors – flow to a diverse range of partners: Canada, Mexico, China, Japan, the EU, and more. This global interconnectedness means the US economy, and therefore the USD, is exposed to a complex web of influences.
The recent economic data, however, is telling a more nuanced story. Strong job growth in November (227,000 jobs added) was encouraging, but weaker-than-expected retail sales in December raised concerns about consumer spending. Inflation remains stubbornly high at 2.9% (December CPI), although core inflation did cool slightly. Q4 GDP growth slowed to 2.3%, a definite miss compared to forecasts. This mixed bag of data makes it difficult to get a clear read on the economy's trajectory.
Market Themes and Narratives: The Fed and Trump Show
Two key themes have dominated market narratives over the past six weeks, intensifying since Trump's inauguration: the Fed's next move and the impact of Trump's policies. The Fed's hawkish turn, evident in the January FOMC minutes, has been a major catalyst for USD strength. The market is now expecting a much slower pace of rate cuts in 2025. But the mixed economic signals – robust jobs numbers alongside weak retail sales, persistent inflation alongside slowing growth – are making traders wonder if the Fed might have to rethink its strategy. Will they stick to their guns, or will the data force their hand?
Then there's Trump. His "America First" policies, particularly the tariff threats, are keeping markets on edge. The initial market reaction to rumors of a more targeted tariff approach was positive, but Trump quickly squashed those hopes. The potential for a trade war is a real concern, and it's adding a significant risk premium to the USD.
Geopolitics: A World on Edge
Geopolitics are always a factor in forex, but with Trump in office, the stakes feel even higher. The US-China rivalry isn't going away, and the recent restrictions on AI chip exports to China have only ratcheted up the tension. The war in Ukraine continues to be a source of instability, and the collapse of the Syrian government adds another layer of geopolitical risk to the mix. All of these factors contribute to a risk-off environment, which is generally positive for the USD. Traders are watching closely for any escalation in these global hotspots, knowing that it could send the USD even higher.
Federal Reserve: Holding Steady for Now
The Federal Reserve, led by Jerome Powell, is navigating a tricky situation. Their dual mandate – maximum employment and price stability (2% inflation) – is being tested by a complex economic and geopolitical backdrop. The FOMC, which sets the all-important federal funds rate, held rates steady at 4.25-4.5% on January 29th. This pause, after three consecutive cuts in 2024, gives them some breathing room to assess the impact of their previous easing and see how Trump's policies play out.
The market, however, is already looking ahead. Most analysts are predicting one more rate cut in the second half of 2025, but that could easily change. The Fed's ongoing quantitative tightening (QT) is also a factor to consider. Traders will be scrutinizing every word from Powell and the FOMC for clues about their next move.
Market Fundamentals: The Dollar's Delicate Balance
The USD is currently riding high, buoyed by the Fed's hawkish stance, safe-haven demand, and the relative strength of the US economy. But this strength is built on a somewhat shaky foundation. Q4 GDP growth was underwhelming at 2.3%, and rising jobless claims suggest the labor market might be losing some steam. Inflation, while showing some signs of moderation in core CPI, is still a concern.
The biggest wild card, of course, is Trump. His trade policies, fiscal plans, and general unpredictability make forecasting the USD's path a tricky business. Will his policies ultimately help or hurt the US economy? The market is divided. Key indicators to watch include the upcoming jobs reports, CPI and PCE data, Q1 GDP growth, and any signals from the Fed. Geopolitical developments, especially those concerning China, will also play a significant role. The USD is strong for now, but its future trajectory remains uncertain. As traders, we need to stay nimble and adapt to the evolving landscape.