The Divergence Unspooling: A Trader's Schizophrenia

It's 2 AM and I'm staring at three Bloomberg screens, each one telling me something different.

Screen one: The euro is at 1.17 against the dollar, struggling for the tenth time this week to break through 1.18. It gained 13% against the greenback in 2025. But it can't seem to go higher, even though everything says it should. The ECB is on pause—rates frozen at 2.0%, inflation at target, Lagarde saying the bank is in a "good place." Meanwhile, the Fed is still cutting. Jerome Powell just delivered the third rate cut in 2025, and the market is pricing two more for 2026. The math is simple: Fed easing, ECB holding. Rate differential narrowing. That should mean EUR up, USD down.

It's up. But not much. Not as much as it should be.

Screen two: Equities. The Dow popped 270 points yesterday on defense stocks alone. Northrop Grumman and Lockheed Martin both surged 7%. Trump announced $1.5 trillion in military spending—a 50% increase funded by tariff proceeds. The market loved it. Temporarily. Then it remembered that tariffs are inflationary. Tariffs crush margins for importers. Tariffs mean Trump is picking fights with China and Mexico and possibly his own central bank. Apple has lost for seven straight days. Nvidia is down. The Nasdaq only gained 0.2% despite this supposed defense boom.

So we have the biggest geopolitical wildcard in a generation saying he'll spend massively on military, and the market is like: "Cool. We'll take some Northrop and then sell Nvidia." That's not conviction. That's tourists.

Screen three: The labor market. This is the one that's keeping me awake.

Initial jobless claims came in at 208,000 last week. Continuing claims just hit 1.91 million, up 56,000 from the prior period. The Fed says the labor market is the fulcrum—if it breaks, they cut harder; if it holds, they pause. But what we're seeing isn't a clean story. Claims are rising (bad for growth) but still below historical average. ADP reported just 41,000 private payrolls created midweek—a miss that should have triggered at least a 50-basis-point rally in bonds. It did. Ten-year yields compressed to around 4.18%, the first real compression in weeks. But equities barely flinched.

Here's what's actually happening, and I can't stop thinking about it: The market is operating under the assumption that the Fed will cut when the labor market starts to show real cracks. But it's not waiting for cracks anymore. It's pricing in the cracks. The labor market shows signs of weakness, bonds rally, equities hold steady because everyone assumes the Fed has its back.

This is a put sale disguised as a bull market.

The Trade That Needs to Snap

EUR/USD is the tell. It sits at 1.17 and cannot break out. The technical resistance at 1.1800 has been tested and rejected repeatedly. But the fundamental case for the euro is unassailable: the rate differential is widening in its favor, growth in Europe is holding (surprise upward revisions all around), and the ECB has simply decided this is good enough. No hiking, no cutting. Just stability.

Yet it can't crack higher.

Why? Because every time it tries, something spooks the dollar bid. Last week it was weak eurozone inflation (good for the euro, bearish for ECB rate hikes). This week it's the idea that maybe the Fed isn't done cutting. These are conflicting signals that the market is trying to digest simultaneously.

The move to 1.20 that everyone's talking about? It's in the cards. But not until something breaks. Either:

(A) The Fed delivers a surprise cut in January, which says the labor market is worse than we think, or
(B) Eurozone data surprises to the upside and forces the ECB to hint at staying higher for longer, narrowing the rate differential from the other side.

Right now we're in the weird suspended state between these two catalysts. The positioning is long euros everywhere you look. Central banks are rotating reserves away from the dollar for the first time in decades. Hedge funds are buying EUR/USD on every dip to 1.1650. And yet the pair can't breathe.

This is a market that knows where it wants to go but hasn't yet convinced itself it's allowed to go there.

Services PMI 54.4 Is a Humbug

Let me get ornery about something: Services PMI came in at 54.4 in December, up from 52.6. That's a 1.8-point jump, and every analyst and their intern is treating it like the economy is humming again.

Manufacturing has contracted for ten months straight. Ten. The word "contraction" does not rhyme with "robust economic growth." But services is holding. So the consensus is: everything is fine, the consumer is fine, the Fed can stay patient, the dollar can weaken more.

Except here's the part nobody mentions in the headline: Services PMI is a soft data point. It measures business sentiment, not actual economic output. Meanwhile, hard data—unit labor costs, actual hiring, actual unemployment trends—is deteriorating. Unit labor costs fell 1.9% in Q4 2024 (good news on inflation, which is why bonds rallied), but that's a lagging indicator. It tells you what happened four months ago, not what's happening now.

The payroll data is the canary. And the canary is getting quieter.

Trump's Defense Spending Announcement Changed Nothing

Here's what I find genuinely bizarre: Trump says he's going to spend $1.5 trillion on defense, financed by tariff revenue. Defense stocks spike. The market priced in a potential growth boost in Q1 and Q2, assuming procurement orders roll out. Then reality remembered that tariffs are anti-growth. You can't goose defense spending to 3.2% of GDP without either cutting something else or raising taxes or running larger deficits—all of which have second-order effects on equities.

The market had a 30-minute window where it believed in defense stimulus. Then it remembered that stimulus + tariffs = stagflation risk. Now it's back to waiting.

And oil? Down 2%. Brent fell below 60 bucks. Trump's Venezuelan oil deal—30 to 50 million barrels coming to the U.S.—spooked the energy market for exactly as long as it took to realize that 50 million barrels is roughly four to six weeks of U.S. consumption. Not exactly transformative. Energy prices have been sliding for weeks on the idea that growth is slowing. One Trump soundbite doesn't change that.

What Actually Happens Next

The jobs report hits at 8:30 AM ET tomorrow (today, actually, as I write this). Consensus is looking for 60,000-70,000 payrolls. Miss that, and bonds will rip—the 10-year could touch 3.9% or lower. Equities will pop on the "Fed will definitely cut" trade. The dollar will weaken. EUR/USD will probably pop to 1.1750 and then stall again because breaking 1.1800 requires conviction.

Beat that number, and we get the opposite. But here's the thing: even if payrolls are weak, it won't mean the Fed cuts in January. It'll just mean they cut at the March meeting. Markets will frontrun that by two months, which creates a 60-day relief rally that doesn't mean anything.

What would actually matter is a shock—payrolls below 40,000, or unemployment spiking to 4.3%, or something that forces the Fed to panic cut. We're nowhere close to that. We're in the zone of "the labor market is softening and the Fed will respond methodically," which is exactly where the market wants to be. Soft enough for cuts. Not so soft that anyone panics.

This is the equilibrium. This is where we camp out for the next two months—stocks at these levels or slightly higher, EUR grinding toward 1.20 in fits and starts, bonds quietly rallying while equities distract everyone with earnings season and AI chatter.

Nobody wants to see the contradiction. So nobody mentions it.

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Check your EUR/USD longs before the data. And check them again after. The answer to what happens next isn't in the data—it's in whether this market has enough conviction to finally let the euro run.