There have been two significant developments that are rocking US equities and sending US yields sharply lower. First, Chinese-made AI has taken the world by storm. Apparently, DeepSeek is cheaper to build, consumes less energy, and is faster than the other AIs. There seems to be innovations outside of replication. The second is a brouhaha over Colombia's initial refusal to accept US military planes bringing back illegal immigrants. There were tariff and counter-tariff threats before the Colombia appears to have capitulated. Trump's quick use of the tariff stick spurred a broad advance in the dollar, but as the Colombia's challenge was resolved, the dollar surrendered most of its early gains. The Mexican peso, however, remains the weakest emerging market currency, trading almost 1% lower on the day. 

The S&P and NASDAQ are poised to gap sharply lower as the futures are trading about 2.5% and 4.5% lower. Asia Pacific equities were mixed after MSCI's regional index rose nearly 2.3% last week. Europe's Stoxx 600 is off by about 0.6%. The sharp equity losses have given US Treasuries a boost. The 10-year yield is off almost a dozen basis points to near 4.50%, the month's low. European benchmark yields are off mostly 3-7 bp. Gold initially fell to around $2747.50 in the Asia Pacific session after settling near $2770.60 ahead of the weekend. It recovered to nearly $2770 in Europe before stalling. March WTI extended last week 3.5% drop and dipped a little below $74 before recovering to approach the pre-weekend high near $75.20. 

USD: The Dollar Index is coming off its first back-to-back weekly loss since the end of September. The technical tone has deteriorated. A close above 107.75, the neckline of a potential head and shoulders pattern is needed to begin stabilizing the technical tone. Without that, the measuring objective of the pattern is around 105.25. The 107.75 area was tested early today on the US threat to impose a tariff on Colombia for refusing US military planes returning illegal immigrants. After a brief spat, Colombia backed down and the Dollar Index has slipped back to around 107.35. The pre-weekend low was near 107.20. The market may turn cautious ahead of the divergent policy moves later this week, and it is subject to headline risk from the drama in Washington. However, the ECB rate cut and Fed standing pat have been widely assumed for several weeks. The anticipation of this divergence helped the lift the greenback earlier. Today's new home sales and the Dallas and Chicago Fed surveys do not have the heft to have much impact, especially ahead of the FOMC meeting and Q4 GDP on Wednesday and Thursday. 

EURO: There is little doubt that the ECB will cut rates this week and signal its intention to extend the easing cycle, and still the euro posted its highest settlement since mid-December last week. The two-year US premium over Germany peaked near 240 bp in late November and settled below 200 bp before the weekend. It has returned to where it was around the US election. It has narrowed for five consecutive weeks and is near 195 bp now. Initial support for the euro was frayed near $1.0460, but the single currency has recovered to push back above $1.05. On the upside, the $1.0560-75 may be the next technical target. 

CNY:  The PBOC has taken advantage of the dollar's pullback to lower the reference rate, which effectively puts a floor under the yuan. It is likely tactical and opportunistic, but consistent with seeking a broadly steady dollar-yuan exchange rate. The efforts to bolster the stock market may also attract capital, which may also support the yuan. The PBOC set the dollar's reference rate today at CNY7.1698, its last fixing until after the Lunar New Year celebration. That puts the 2% band at about CNY7.0265-CNY7.3130. Mainland markets re-open on February 5. Typically, the offshore yuan does not move much net-net without the onshore market. Last week was the first back-to-back weekly dollar loss against the offshore yuan since the end of September. The roughly 1.35% weekly decline in the greenback was the largest in two years. It is trading within the pre-weekend range. China's January PMI disappointed. The manufacturing PMI slipped back below the 50 boom/bust to 49.1from 50.1. The non-manufacturing PMI fell to 50.2 from 52.2. The composite stands at 50.1, down from 52.2.

JPY:  Falling US rates has helped push the dollar out of its JPY154.80 and JPY156.75 recent range against the yen. It was sold to a new low for the month near JPY153.75, which is the (50%) retracement of the dollar's gains since the early December low near JPY148.65.  With the BOJ rate hike out of the way, and a light economic calendar until the end of the week, the exchange rate may be more sensitive to the directional cues from long-term US rates. The intraday momentum indicators are oversold, suggesting limited follow-through in early North American activity. 

GBP: Sterling posted its highest close before the weekend since January 6, a little below $1.2480. Its nearly 2.5% gain was the first weekly gain of the year and the biggest since November 2022. The preliminary January PMI for the first time in five months, but sterling's gains did not seem spurred by favorable UK developments but rather the broad dollar setback. Sterling recovered from the initial wobble that took it to about $1.2425 to test the $1.2500 are in the European morning. The technical tone is constructive and there appears potential back to the $1.2575-$1.2610 area before having to decide whether this is a correction or a trend reversal.

CAD:  The Canadian dollar was more like the Japanese yen last week in the sense that it trended broadly sideways rather than trend higher as most of the other exchange rates we track here. It did rise by almost 1%, but after some dramatic swings last Monday and Tuesday, it settled into a CAD1.4300-CAD1.4415 range in the second half of the week. The Bank of Canada's rate decision is a several hours before the Federal Reserve's decision on Wednesday. Unlike the narrowing of the US premium over Germany, the US two-year premium over Canada remains near its widest since 1997 and may help explain why the Canadian dollar has been unable to sustain a stronger recovery amid the broader US dollar pullback. The greenback is in a range so far today between about CAD1.4330 and CAD1.4400. The high was made amid the US tariff threat on Colombia, but the pullback has been limited to the CAD1.4350 area. 

AUD: The Aussie finished last week above $0.6300, which had stymied it in recent weeks. It settled above the down trendline from September. It approached $0.6340, which is the (38.2%) retracement of the losses since around the US election. A close now below $0.6280 would be disappointing. It slipped slightly below there in early trading today when the greenback jumped on the tariff announcement. It is pushing against $0.6300 again in the European morning, but the intraday momentum indicators are getting stretched, suggesting the $0.6310-20 area may be a sufficient cap. The market favors a rate cut next month to begin the easing cycle, and the Wednesday's Q4 CPI does not look likely to stand in the way. Headline and underlying measures are expected to ease. Australia's biggest trading partner is China, putting it somewhat less in new US administration's crosshairs. Australia runs a relatively small bilateral trade surplus with the US (~A$25 bln in 2023). 

MXN:  The US tariff threats injected volatility into the exchange rate but by the end of last week, the peso rose by about 2.5% making the first week of Trump's second term, the best for the peso since last September. Ahead of the weekend, the dollar reached its lowest level against the peso since Christmas Eve (~MXN20.1345). The tariff threat on Colombia saw the dollar jumped to MXN20.51. AS we have noted before, the Mexican peso trade 24-hours a day and is used as a proxy foe less liquid emerging market currencies or the asset class as a whole. Trump himself suggested February 1 as a possible time to hike tariffs on imports from Mexico may keep the peso on the defensive. Last week's report that showed softer headline inflation for the first half of January keeps the market looking for a quarter-point rate cut at the next Banxico meeting in early February. Mexico reports its trade December figures today. Although Mexico had a nearly $40 bln trade surplus with the US through November, nearly half of the US imports from Mexico are from affiliates of US companies.  

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