The dollar weakened broadly on Monday as reports suggested a potential softening of U.S. tariff policies under the incoming administration. While President-elect Donald Trump refuted the reports, calling them "Fake News" and reiterating a robust trade stance, the market’s initial reaction underscored the sensitivity of currencies and equities to shifts in U.S. trade policy expectations. Investors remained focused on upcoming economic data, particularly Friday’s non-farm payrolls report.

Yen Outperforms Amid BOJ Signals of Potential Rate Hikes

Unlike other major currencies, the yen underperformed the broader rally against the dollar, with USD/JPY posting modest gains. BOJ Governor Kazuo Ueda suggested the central bank could consider further rate hikes if economic conditions continue to improve, though he cautioned against hasty decisions, keeping market participants attuned to upcoming BOJ policy signals.

U.S. Data Highlights Manufacturing Weakness Amid Stable Yields

U.S. economic data presented a mixed picture, with the December S&P Global final composite PMI falling to 55.4, down from a flash estimate of 56.6, while the services PMI dropped to 56.8 from 58.5. November factory orders declined more than expected, reflecting ongoing challenges in the manufacturing sector. Treasury yields were steady at the short end but rose 2-4 basis points in longer maturities, signaling cautious optimism about longer-term growth prospects.

Equities and Commodities Reflect Trade Optimism and Risk-On Sentiment

U.S. equities rallied, with the S&P 500 gaining 0.66%, led by semiconductor stocks buoyed by AI-related growth expectations and optimism surrounding a potential easing of U.S. trade policies. Commodity markets showed mixed performance:

• WTI Crude Oil: Fell 0.95%, retreating from a 12-week high as a winter storm boosted short-term energy demand.
• Copper: Rallied 2%, driven by hopes that softer U.S. tariffs could support industrial activity and global trade.
• Gold: Eased 0.18% amid reduced haven demand as risk sentiment improved.

Currency Market Performance Reflects Risk-On Flows

• EUR/USD: Gained 0.74%, supported by improved market sentiment and technical short-covering.
• GBP/USD: Rose 0.74%, buoyed by risk-on flows and reduced dollar strength.
• AUD/USD: Climbed 0.38%, benefiting from stronger commodity prices and risk-sensitive inflows.
• Cross-Currency Pairs: EUR/JPY and GBP/JPY posted strong gains of 0.88% and 0.85%, respectively, reflecting broader optimism across risk-sensitive assets.

Market Outlook: U.S. Trade Policies and Payroll Data in Focus

• Dollar: Its trajectory will hinge on further clarity about U.S. trade policies under the incoming administration and key economic releases, particularly non-farm payrolls data.
• Yen: May face volatility depending on BOJ signals about rate hikes, with attention on Governor Ueda’s commentary.
• Euro and Pound: Could see continued support if risk sentiment stays positive, though gains may be tempered by regional economic data.
• Commodity-Linked Currencies: Australian dollar and peers are poised to benefit from rising industrial metal prices and global trade optimism, though renewed dollar strength could limit gains.

Conclusion: Markets Brace for Policy Clarity and Key Economic Data

The dollar faces near-term headwinds amid mixed U.S. trade policy signals and improving global sentiment, while currencies like the euro, pound, and Australian dollar capitalize on risk-on flows. The yen’s performance hinges on BOJ guidance and Treasury yield trends, while commodities reflect a balancing act between trade optimism and economic uncertainties. Markets are expected to remain sensitive to central bank commentary, U.S. economic data, and geopolitical developments as investors position for policy shifts heading into 2024.