The U.S. dollar edged lower on Tuesday as advancing equity markets and declining energy prices boosted risk sentiment. The favorable tone followed President Donald Trump’s initial policy actions after returning to office, which spurred optimism across markets. The S&P 500 climbed 0.86%, with nearly all sectors posting gains, reflecting broad-based buying interest.

Euro Climbs on Short-Covering and Strong Bund Yields

The euro reached a three-week high, advancing 0.18% against the dollar as short-covering supported gains. However, large options expiries near the 1.04 level limited further upside. Bund yields firmed after France’s first syndicated bond sale since its snap election drew record demand, underscoring robust appetite for European assets.

Sterling Stable Amid Mixed U.K. Data and Robust Gilt Demand

The pound traded little changed, with GBP/USD edging up 0.06% after mixed U.K. employment data and record demand for a 15-year gilt auction. British finance minister Rachel Reeves leveraged the Davos forum to encourage corporate investment in the U.K., but broader market uncertainties capped sterling’s gains.

Yen Rises on BOJ Speculation and Lower U.S. Yields

The yen gained 0.15% against the dollar as U.S. Treasury 10-year yields and inflation break-evens fell. A Kyodo News report suggesting the Bank of Japan may raise its key short-term rate by 25 basis points this week added to the yen’s strength, fueling expectations of a policy shift amid Japan’s inflationary pressures.

Commodity Currencies Defensive Amid Energy Market Volatility

Commodity-linked currencies like the Canadian dollar and Mexican peso traded cautiously after President Trump hinted at potential tariffs on Canada and Mexico starting February 1. Canadian inflation slowed to an annualized 1.8% in December, further pressuring the loonie. Meanwhile, AUD/USD traded flat, gaining 0.06% as risk sentiment stabilized but broader concerns over energy markets and geopolitical risks capped gains.

Commodities: Gold Gains as Oil and Gas Decline

• Oil: Fell 2.3% as President Trump declared a U.S. energy emergency, pushing for higher domestic output to stabilize markets.
• Natural Gas: Dropped 5%, reflecting supply adjustments amid warmer weather forecasts.
• Gold: Rose 1.37%, driven by hedging against Trump-related policy risks.
• Copper: Slipped 0.73%, weighed down by industrial demand concerns and earlier dollar strength.

Treasury Yields Reflect Mixed Sentiment

U.S. Treasury yields presented a mixed picture, with the curve flattening slightly while the 2s-10s spread widened by 5 basis points to +28.7bp. Markets balanced growth risks against policy uncertainties, keeping the overall yield environment subdued.

Currency Market Movements Reflect Shifting Sentiment

• EUR/USD: Gained 0.18%, supported by short-covering and firm European yields, though gains were capped by technical resistance near 1.04.
• USD/JPY: Slipped 0.15%, reflecting yen strength tied to lower U.S. yields and speculation about BOJ policy shifts.
• GBP/USD: Edged up 0.06%, underpinned by steady gilt yields and robust U.K. debt demand.
• AUD/USD: Traded flat, rising 0.06% as risk sentiment improved, but broader energy market concerns limited upside.
• Cross-Currency Pairs: EUR/JPY and GBP/JPY were largely unchanged, while AUD/JPY declined 0.12%, reflecting mixed commodity and risk sentiment.

Market Outlook: BOJ Policy and Trump Developments in Focus

• Dollar: Likely to remain sensitive to U.S. policy announcements and inflation expectations, with Trump’s trade agenda adding potential volatility.
• Euro: Poised to benefit from European yield support but constrained by technical resistance and geopolitical risks.
• Yen: Expected to remain strong if the BOJ signals a rate hike or if global uncertainties persist.
• Pound: Faces limited upside unless U.K. data or BOE signals provide stronger direction amid ongoing political uncertainties.
• Commodity Currencies: Australian and Canadian dollars could benefit from stabilized risk sentiment but remain vulnerable to energy market volatility and trade risks.

Conclusion: Markets Navigate Policy Speculation and Geopolitical Risks

The dollar’s retreat reflects shifting sentiment amid optimism over U.S.-China relations and easing Treasury yields. The euro and yen capitalized on these dynamics, while sterling and commodity-linked currencies traded cautiously amid mixed data and geopolitical uncertainties. With the Bank of Japan’s policy decision and Trump’s evolving trade agenda dominating the near-term outlook, markets are poised for heightened volatility as key developments unfold.