Currency markets are suffering a case of whiplash after Donald Trump yesterday denied a report saying that his aides were exploring plans to implement a narrower set of tariffs than had been promised on the campaign trail. The article in the Washington Post, which suggested that the incoming administration would impose selective rather than universal tariffs, triggered a 1-percent drop in the dollar, but was rebutted a little more than three hours later by the president-elect in a Truth Social post in which he called it “fake news”. The greenback ended the day down roughly 0.7 percent as traders adopted a “where there’s smoke, there’s fire” interpretation, following a playbook established over dozens of similar episodes during the first Trump administration.

But the day’s events showed—if any evidence was required—that Trump’s threats have not been fully incorporated into market prices. In theory, US tariffs should be partially offset by an appreciation in the dollar and a sharp depreciation in the currencies suffering the biggest potential hit to exports. That the round-trip in foreign exchange markets amounted to less than 1.7 percent in currencies like the Chinese renminbi, Canadian dollar, and Mexican peso indicates that this has not yet taken place—at least not to the extent that would be consistent with tariff loads exceeding 20 percent—and suggests that downside risks remain significant in the currencies most dependent on US exports.

The Canadian dollar is trading on a firmer basis, up roughly 0.9 percent from Friday’s close. It may be tempting to ascribe this to Prime Minister Justin Trudeau’s decision to step down yesterday, but as the chart above illustrates, the currency’s performance puts it in the middle of the pack among major currencies, suggesting that traders don’t see short-term domestic political developments changing the longer-term economic calculus that has kept the exchange rate under pressure.

The euro is clinging to small gains against its major peers after inflation in the single currency area met expectations in December, keeping the European Central Bank on track toward cutting rates several times this year. According to a preliminary estimate published by Eurostat this morning, headline consumer prices climbed 2.4 percent in the year to December, core inflation held at 2.7 percent, and services-sector price growth hit 4 percent. Policymakers, including central bank president Christine Lagarde, have long warned that progress would be “bumpy” in the winter months, and few doubt that disinflationary processes will ultimately give officials room to push rates lower. We have our doubts, but a broad-based contingent of speculators and forecasters expect the common currency to fall below parity with the dollar again in the next quarter or two.

The Institute for Supply Management’s gauge of non-manufacturing activity is seen accelerating in December, helping maintain market confidence in the exceptionalism of the US economy. The services sector, which dwarfs manufacturing as the biggest contributor to overall growth, has remained in strongly expansionary territory for much of the last two years, more than offsetting a post-pandemic normalisation in tangible goods-related industries, and (arguably) limiting the utility of normal business cycle indicators in assessing the strength of the broader economy.

This morning’s US Job Openings and Labor Turnover Survey is expected to show the vacancy-to-unemployed worker ratio moving below 1.10 in November, signalling a continued moderation in underlying job market conditions toward a more balanced state. We think this will ultimately translate into a stepped-up pace of easing from the Federal Reserve, but for now, should reinforce expectations for a prolonged downshift in the cadence of rate cuts. In a speech given yesterday, Governor Lisa Cook said “All along, I envisioned moving more quickly in the early stages of our easing campaign and then easing more gradually as the policy rate came closer to neutral. In addition, since September, the labour market has been somewhat more resilient, while inflation has been stickier than I assumed at that time. Thus, I think we can afford to proceed more cautiously with further cuts”.

The data calendar is otherwise quiet, leaving us to ponder where the biggest threat to current market assumptions might be located. Contrary to the prevailing wisdom, we suspect that Donald Trump might not represent the clearest potential for a big, destabilising move in global financial markets. Market prices themselves should act as a correcting influence on the extreme economic policy shifts that might have otherwise been implemented*. Instead, the US capital markets represent the most obvious source of risk: after a multi-decade tech boom, equities simply look over-concentrated, overpriced, and overvalued relative to the scale of the economy. The “Warren Buffett indicator”—which measures the value of the publicly-listed equities against the amount of gross domestic product generated each year—has reached new heights in the last year, with parabolic price behaviour looking eerily reminiscent of the run-ups seen prior to market crashes in 1929, 2000, and 2008.

We’re reminded of Uncle Warren’s 2000 investment letter, in which he said: “The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money. After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities—that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future—will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.”

*We’re relying here on the wisdom of Bill Clinton’s chief political strategist James Carville, who said: “I used to think that if there was reincarnation, I wanted to come back as the President or the Pope or as a .400 baseball hitter. But now I would want to come back as the bond market. You can intimidate anybody”.

**Yes, we’re aware that this measure compares a stock (market capitalisation) with a flow (gross domestic product), but it nonetheless captures a basic relationship between financial asset valuations and overall output.