Merlin Weekly Macro: 2026 has begun with a bang

Unbelievably, it is the end of January already. Christmas, the season of Peace on Earth and Goodwill to Mankind, is fast receding as a dim memory. More optimistically, rather than pitch darkness there is now a glimmer of dawn in the morning sky at the God-unearthly hour your correspondent departs the house to do the two-hour door-to-door commute to the London office from South Lincolnshire.

2026: an explosive start

In almost every sense, 2026 has begun with a bang. Literally so for Venezuela and Ukraine. At the time of writing, to use the Trumpian vernacular “Hell” is possibly about to be “rained” upon Iran; the death-toll since Christmas is now measured in the tens of thousands as a deeply repressive and paranoid theocratic regime uses extreme force to suppress what has rapidly turned in less than a month from peaceful protests in a Tehran bazaar about sanction-induced poverty into a nationwide mood of rebellion and riot. Of at least as much interest to Trump is the eradication of all Iran’s nuclear capability. He is prepared to enforce his view through brute military force (his “big, beautiful Armada” amassing in the Gulf and the Eastern Mediterranean, led by the nuclear-powered aircraft carrier USS Abraham Lincoln; all assets have ‘gone dark’, electronic signatures and transponders all switched to ‘silent’).

Reflecting global instability, asset volatility has been the order of the day.

Commodities: do trees grow to the moon?

Commodity prices are roofing it. The focus is on gold (+27% YTD). Last week we wrote that “No wonder the gold price is rapidly approaching $5,000 an ounce. A year ago on Trump’s inauguration, it was $2,700. That doubling has little to do with the inflation outlook”; a mere seven days later the price reached $5,535 per ounce. The silver price chart (+61% YTD) is parabolic over a year. Copper, relatively stable for most of the month (+16% YTD) at one point was up nearly 11% in the day as this was being written. Brent crude, $60 per barrel at the turn of the year, shot through $70 and at $71.6 had risen 19% since January 1st before calming a little. Exacerbated by the almost nationwide deep freeze in the US lifting demand while simultaneously supplies have been disrupted through gas plant shut-downs, the price of natural gas has been highly volatile (happily not yet combustible!).

Trees do not grow to the moon; even if the trends remain intact in commodity prices, and each has its own idiosyncratic drivers within the immutable laws of supply and demand, a near-term reaction would be expected if conditions improved (e.g. were Iran and the US to reach a bloodless accommodation over the Iranian nuclear programme which might also lead to a relaxation in sanctions, we should expect a correction in the price of Brent towards its recent more natural level in the low $60s per barrel).

Spotlight on the dollar

As we have said, there are idiosyncratic reasons specific to the price behaviour of each of these commodities. However, linking all of them is the weakness in the dollar, the currency in which they are all priced and traded.

DXY, the dollar value expressed as an index against a basket of major currencies, stands at 96.2; it was 99.4 on 18 January (a fall of 3% in 10 days) but was 109 a year ago (i.e. a depreciation of over 12%, significant bearing in mind the US dollar is the world’s leading strategic reserve currency; the corollary of the dollar’s weakness is that other comparative currencies have risen in value but to be clear, Sterling appreciating to $1.38 from $1.23 a year ago has almost everything to do with the dollar’s weakness and little to do with fundamental confidence either in the pound or the UK economy).

The focus on the currency leads inevitably to scrutiny of the Federal Reserve (Fed) and Donald Trump. The US central bank policy committee met this week and resolved, not unanimously but by a majority, to keep interest rates on hold in the official target range of 3.5-3.75%. The most recent headline CPI inflation data points to prices rising at 2.7%, above the Fed’s mandated target to achieve an average rate of 2%.

The Fed’s problems which betray deep tensions are two-fold. The first is economic. With the massive fiscal stimulus from Treasury Secretary Scott Bessent implementing President Trump’s re-industrialisation, infrastructure and defence re-investment strategy helped by sweeping tax cuts, and the monetary stimulus from six interest rate cuts over 18 months, the economy is buzzing. Indeed, it is in danger of overheating. The respected Atlanta Fed economics team estimates that the current annualised GDP growth rate for the US is topping 5%. Any thoughts of a possible US recession have evaporated. Adding to the inflationary pressure, even if temporary, is the current spike in industrial commodity prices as discussed above. Intuitively, the Fed should be applying the brakes rather than coasting in neutral, and certainly not entertaining any thoughts of pressing the accelerator with further rate cuts at this point.

The Triffin Paradox

Why therefore were two governors voting for a further quarter point cut, potentially adding to that stimulus? The Fed’s second point of tension is both political and philosophical.

The Triffin Paradox is defined by Wikipedia as “the conflict of economic interests that arises between short-term domestic and long-term international objectives for countries whose currencies serve as global reserve currencies”. Stephen Miran is Trump’s trusted personal economic adviser and a recently appointed Fed Governor. Miran has made numerous appearances in these columns over the past 12 months. Regular readers will know he is the author of the dry but essential “A User’s Guide to Restructuring the Global Trading System” (November 2024, Hudson Bay Capital) and is the architect of Trump’s trade strategy. Trump has followed Miran’s tariff script to the letter as a means of rebalancing the economy and addressing trade deficits with targeted counterparties. Miran’s Chapter Two, “Theoretical Underpinnings: the roots of the economic discontent lie in the dollar” directly addresses the Triffin Paradox. Miran argues that because of its leading reserve currency status the dollar has been structurally overvalued for too long, to America’s economic competitive disadvantage. He has argued strongly for a weaker US exchange rate. A weaker dollar is entirely consistent with a tariff strategy designed to make imports into the US more expensive and exports from the US more competitive.

In Davos, Trump did not spare the current Fed Chairman Jerome “always late” Powell in a searing critique of what Trump sees as the chief central banker’s shortcomings. Powell is due to retire the chair in May; Trump announced he has selected Kevin Warsh as the next chairman. Paraphrased in his speech to the great-and-good of the global economic, business and political establishment, Trump levelled the accusation that “everyone who gets appointed to these jobs becomes a disappointment; they all change once they get the job, they all change. Strange but they do”. By which he implies that they say what he wants to hear to get appointed and then do the opposite of what he wants once they are in post. No wonder he is viewed as some kind of belligerent, insurgent outsider in such circles.

This undermining of the authority and the independence of the Fed is an effective means of ‘talking down’ the tactical value of the dollar; but it becomes illiterate to the point of being counterproductive if it also undermines the strategic power of the dollar and reduces the geostrategic leverage that accrues to the US through the dollar’s position as the world’s principal reserve currency. The dollar underpins the security of global commodity and financial markets and their settlement systems.

Whomever is appointed to what may be described as a prestigious poisoned chalice is on notice that failure to comply with Trump’s wishes presages a torrent of verbal ordure; humiliation from on high. Volunteers, anyone?

Bond vigilantes go with the flow

Bond investors are reacting to the new circumstances. Sovereign bond yields have been volatile but generally rising again as the immediate prospect of US rate cuts diminishes and the ‘terminal rate’ (i.e. where the central bank signals no more policy loosening) looks like settling higher than was anticipated a couple of years ago. That period was when investors were riding the down-hill side of the post-Covid, post-invasion of Ukraine inflation roller-coaster since when inflation rates have tended to settle at higher levels than those prevailing before 2020, and in the UK and the US at levels above their respective central bank’s targets.

There is always a natural tension between investors who provide capital and the central banks which set the benchmark cost of capital through the interest rate. They approach a single number from very different perspectives: investors need/want to make money; central banks are there to manage economic inflation and to maintain orderly markets. In some cases the banks have a dual mandate (e.g. the Fed’s is to maximise employment, while in Europe, the ECB’s is to help member states achieve carbon net-zero targets through facilitating investment).

Both parties are looking for all and any evidence which supports their point of view. Monetary policy, the central banker’s province, is as much an art as a science. Far from precision instruments, interest rates are a blunt tool. A change in policy might take at least a year, possibly two, to show a tangible result. Central bankers are castigated when they get it wrong and seldom get any praise when they get it right. And that’s without Donald Trump calling you a “moron”, a “loser”, the “worst appointment I ever made” and worse.

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