Pound Sterling Recovers as TACO Trade Plays True

File image of U.S. President Donald Trump at the WEF in Davos, copyright by World Economic Forum / Mattias Nutt.

Traders welcome news Donald Trump had backed down over Greenland.

Pound sterling recovered against the euro and safe-haven currencies as tariff threats were dropped.

Trump said he had agreed upon a "future framework" for Greenland during a "very productive meeting" with Mark Rutte, Nato’s secretary general.

Trump Always Chickens Out (TACO) is a profitable financial market where investors buy the dips that follow Donald Trump's various threats.

The trade delivered again when Trump confirmed he was dropping tariff threats on European nations over their unwillingness to back his desire to buy Denmark. Earlier, during a speech in Davos, he signalled a climbdown was in the offing by saying he would not use force to acquire Greenland.

"Assets across sectors posted major relief rallies as Trump backed down from Feb 1 tariffs on Europe while also ruling out taking Greenland by force," says Michael Tang, an analyst at Commonwealth Bank.

Above: GBP/EUR recovers about half its losses.

The impact on FX markets was noticeable, albeit unremarkable: safe-havens fell back and the losers of the initial tariff news recovered some ground.

The pound to euro exchange rate lifted from lows at 1.1439 to close the day at 1.1489 for a gain of a quarter of a per cent.

The pound to dollar exchange rate edged lower by 0.09% to end the day at 1.3427. Thursday sees both GBP pairs holding close to these levels.

The dollar fell sharply on the initial tariff news as investors judged Trump's actions were damaging to U.S. interests and harmful to the domestic consumer.

The USD didn't fully capitalise on the TACO recovery trade, however, due to Trump's strident comments about the U.S. Federal Reserve during his address to the WEF in Davos.

There, he reiterated his strong desire to see lower interest rates at the Federal Reserve as he dwelt on the state of the U.S. economy. 

"Jerome to-late-Powell, he's always too late," said Trump in his address, criticising the Fed's cautious approach to lowering interest rates owing to persistent inflationary pressures in the economy.

"We're going to have somebody great and we hope he will do a good job," he added, referencing his yet unnamed pick to replace Powell.

Above: Nomura's bespoke measure of 'sell America' action rose on Greenland threats.

The Davos speech was largely aimed at his domestic audience, and he made it clear he is focused on the cost of living and lowering interest rates will be a key objective of the White House ahead of the midterm elections due at the end of the year.

Expectations for lower rates tend to weigh on the dollar and explain why there was not a complete reversal of the Monday and Tuesday selloffs.

The USD recovery was constrained by the comments, which impacts the entire FX market. For instance, the euro is allowed to hold onto most of Monday and Tuesday's gains, denying the pound-euro exchange rate the chance to recoup its losses.

With geopolitics settling down again, we would anticipate markets to return their gaze to data and central bank policy issues.

Next up for sterling is Thursday's PMI release for January and Friday's December retail sales results.

Strong readings here would help it recover further.