Day: November 22, 2024

The U.S. dollar surged to its highest level in over two years against a basket of currencies on Friday, extending its rally to an eighth consecutive week — the longest winning streak in 14 months.

A wave of weaker-than-expected business activity data from Europe has weighed heavily on the euro and the British pound, as investors brace for faster rate cuts by the European Central Bank (ECB) and the Bank of England (BoE).

Eurozone PMI Dives Into Contraction

In November, private-sector activity in the eurozone unexpectedly contracted, triggering fresh concerns about the region’s economic outlook.

The Composite Purchasing Managers’ Index (PMI), compiled by S&P Global, fell to 48.1, well below the neutral 50 threshold and missing forecasts for an unchanged reading. This marks the first contraction in eurozone business activity since January.

The downturn was driven by a drop in new orders, higher input prices, and escalating political uncertainty.

Chris Williamson, chief business economist at S&P Global, commented: “The flash PMI survey data for November showed the eurozone economy falling back into contraction, as malaise spread from the struggling manufacturing sector to the larger services economy.”

UK Economy Also Contracts

Across the Channel, the UK also delivered a disappointing PMI reading. The Composite PMI fell to 49.9, a drop from the previous month’s 51.8, and below market expectations of 51.7.

This marks the first contraction in UK private-sector activity since October 2023.

“The November PMI is indicative of the economy slipping into a modest decline, with GDP dropping at a 0.1% quarterly rate, but the loss of confidence hints at worse to come – including further job losses -unless sentiment revives,” Williamson said.

Dollar Index Climbs as Euro, Pound Tumble

The U.S. Dollar Index (DXY), a key measure of the greenback’s performance which is closely tracked by the Invesco DB USD Index Bullish Fund ETF UUP, climbed above 107 — a level last seen on Nov. 18, 2022.

The euro plunged to 1.04 against the dollar, its lowest level in two years. The pound fell to 1.25, on track for its eighth straight weekly loss — the longest losing streak since 1980.

On Friday, S&P Global will release flash PMI data for the U.S. economy at 9.45 a.m. ET. Economists predict the Services PMI to edge higher from 55 to 55.2 in November, which would mark the strongest expansion since August.

Manufacturing momentum is also expected to improve from 48.5 to 48.8, albeit remaining in contractionary territory.

Analysts: Euro Vulnerable Amid Weak Data And Geopolitical Risks

Forex analysts point to several catalysts for the euro’s sharp decline.

“The worsening of the Ukrainian crisis has opened up a phase of risk aversion, hitting the EUR and GBP,” said Luca Cigognini, a forex strategist at Intesa Sanpaolo.

Chris Turner, an analyst at ING Group, highlighted the technical significance of the euro’s drop: “Today’s release of softer-than-expected eurozone PMIs proved the catalyst for EUR/USD to break to the downside of its two-year trading range. Even though a near 7% drop in just two months is exceptionally rapid by historical standards, we remain confident in a lower EUR/USD trajectory. Support is limited, with the next key level around 1.0190/1.0200.”

BBVA analyst Alejandro Cuadrado echoed similar concerns, pointing out that additional downside pressure on the euro could arise from political instability in Germany, the outcome of the U.S. elections, and intensifying geopolitical risks.

“The tense situation in Europe could worsen in the short term, and investors are clearly taking a cautious approach on the EUR,” he said.

Cuadrado’s colleague, Michalis Onisiforou, shed light on Germany’s economic struggles: “The collapse of Germany’s coalition government and early elections mean there won’t be any immediate fiscal response to alleviate the pessimism surrounding the domestic economy. Coupled with escalating risks in the Russo-Ukrainian war, Germany faces significant headwinds.”

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The U.S. economy could face a high-stakes, casino-like scenario in 2025, with risks swinging between a potential boom fueled by tax cuts and deregulation and a possible stagflationary bust triggered by policy uncertainty and trade restrictions.

This is the core message from JPMorgan’s chief economist, Michael Feroli, who laid out a sharply divided economic outlook shaped by the red sweep in the 2024 elections and the early policy indications from the incoming Donald Trump administration.

Dueling Narratives For 2025: Economic Boom Or Stagflation

In a note shared with clients earlier this week, Feroli presented competing narratives about the direction of the U.S. economy in 2025.

“One path sees tax cuts and deregulation unleashing animal spirits, thereby boosting productivity growth and GDP,” the economist wrote.

“The other path foresees policy uncertainty hindering growth, while trade and immigration restrictions impart a stagflationary bias,” he added.

Striking a balance between two extremes, JPMorgan projects a modest slowdown in growth to 2% in 2025, accompanied by a slight uptick in unemployment to 4.5%.

Feroli highlights that the U.S. Federal Reserve’s dual mandate of maximum employment and stable inflation faces a complex road ahead.

While inflation risks have moderated compared to two years ago, core PCE (the Fed’s preferred inflation gauge) remains stubbornly high, hovering in the upper 2% range. Simultaneously, the labor market is slowing but hasn’t bottomed in a way that assures confidence in avoiding further unemployment increases.

“Next year’s outlook is cloudier than normal,” the investment bank wrote.

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Policy and Tariff Risks on the Horizon

Immigration and Labor Supply

Immigration policy is expected to take center stage in 2025 under the Trump administration.

A reduction in net immigration could significantly dampen labor supply growth, employment gains, and overall GDP expansion.

JPMorgan projects that immigration restrictions will tighten labor markets, potentially curbing economic growth over the long term.

Yet, they “don’t anticipate immigration policy will have first-order effects on inflation.”

Tariffs On China And Inflation Effects

On trade policy, JPMorgan assumes a 60% across-the-board tariff on Chinese imports will likely be implemented in 2025.

Tariffs on imports from other countries are expected to remain more limited in scope, though their potential introduction could further disrupt supply chains.

Currently, U.S. tariffs on Chinese goods stand at 11%. A steep increase to 60% would represent a dramatic escalation and could significantly strain the U.S.-China trade relationship.

While the broader economic impact is still uncertain, Feroli warns of inflationary pressures arising from such protectionist measures.

“Based on the volume of trade, the U.S. would be levying $215bn in taxes on Chinese imports and China would be levying just over $70bn in taxes on US exports,” he stated.

JPMorgan anticipates further progress toward the Fed’s 2% inflation target in 2025.

However, policies proposed by President-elect Trump, particularly higher tariffs on China, pose a risk of modestly higher inflation. The most significant impact is expected midyear, as increased tariffs could temporarily lift prices.

As a result, JPMorgan forecasts core PCE inflation to run at 2.3% by the end of 2025, before gradually aligning with the Fed’s 2% target in 2026.

The Fiscal Deficit: A Growing Challenge

Fiscal policy is also under scrutiny, as the U.S. budget deficit is projected to expand significantly in the years ahead.

The Trump administration and a Republican-controlled Congress are expected to extend the 2017 Tax Cuts and Jobs Act (TCJA), whose personal income tax provisions are set to expire at the end of 2025.

“We expect essentially all the current tax code will be extended, which we project will mean a federal fiscal deficit of around 7% of GDP in 2026, at a time when we are at full employment and not directly involved in a war. The vagaries of the business cycle and geopolitics both skew risks toward a wider deficit,” Feroli said.

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Image created using artificial intelligence via Midjourney.