Dollar Firm as U.S. and China De-escalate

May 12, 2025

Win Thin

The U.S. and China have agreed to temporarily lower tariffs; market expectations for Fed easing have fallen; the Q2 growth outlook is solid
Some ECB officials are pushing back against easing expectations; the bar for back-to-back BOE cuts is high
Japan reported March current account data

The dollar is firm as trade tensions ease. DXY is trading higher near 101.795 after the U.S. and China temporarily suspended tariffs after weekend talks (see below). The yen and Swiss franc are underperforming, with USD/JPY trading higher near 148.55 and EUR/CHF trading higher near .93840. Elsewhere, the euro is trading lower near $1.1080 and sterling is trading lower near $1.3155. While we continue to view any dollar relief rallies with skepticism, easing trade tensions have removed a significant headwind on the dollar, at least for now. A significant trade deal with China will be very difficult to strike over 90 days and the clock is ticking.

AMERICAS

The U.S. and China have agreed to temporarily lower tariffs. U.S. tariffs on China will be cut to 30% and China’s tariffs on the U.S. will be cut to 10% for a 90-day cooling off period. Treasury Secretary Bessent said “We are in agreement that neither side wants to decouple,” adding that “We would like to see China open to more US goods. We expect that as the negotiations proceed, that there will also be the possibility of purchase agreements to pull what is our largest bilateral trade deficit into balance.” While the White House touted it as a trade deal, it is nothing of the sort as the sectoral tariffs as well tariffs from Trump’s first term remain in place. Nothing of substance could be agreed upon after only two days of talks, but it’s clear that both sides are looking to de-escalate the situation. Stay tuned.

Market expectations for Fed easing have fallen. The odds of a June cut have fallen below 10%, rising to around 45% in July and fully priced in for September. Looking ahead, the swaps market is pricing in 75 bp of total easing over the next 12 month, down from 125 bp last week. There are plenty of Fed speakers this week. Kugler speaks today.

The Q2 growth outlook is solid. The Atlanta Fed GDPNow model has Q2 growth at 2.3% SAAR now and is nearly back at the initial estimate of 2.4%. It will be updated Thursday after the data. Elsewhere, the New York Fed Nowcast model has Q2 at 2.4% SAAR and will be updated Friday, while its initial Q3 estimate will come at the end of May.

EUROPE/MIDDLE EAST/AFRICA

Some European Central Bank officials are pushing back against easing expectations. Executive Board member Schnabel argued in favor of keeping interest rates near their current levels. Schnabel noted “We are thus in a good place to evaluate the likely future evolution of the economy and to take action if risks materialize that threaten price stability.” A 25 bp cut to 2.00% at the next meeting June 5 is about 85% priced in. Looking ahead, the swaps market is pricing in about 50 bp of total easing over the next 12 months, down from nearly 75 bp earlier this month.

The bar for back-to-back Bank of England cuts is high. Deputy Governor Lombardelli confirmed she was balanced between holding and cutting rates coming into the May policy meeting. Ultimately she voted in favor a 25 bp cut due to the “combination of further gradual progress on disinflation and the trade developments.” Odds of a June cut are only about 15%. At last week’s meeting, the MPC voted by a majority of 5-2-2 to cut rates 25 bp to 4.25%. Two members preferred to cut rates by 50 bp (Taylor and Dhingra) and two members preferred to keep rates unchanged (Mann and Pill). We hear from Greene, Mann, and Taylor later today. Bottom line: the BOE’s cautions easing cycle, the US-UK trade deal, and warmer UK-EU relations bode well for GBP versus EUR.

ASIA

Japan reported March current account data. The adjusted surplus came in at JPY2.723 trln vs. JPY2.465 trln expected and a revised JPY2.906 trln (was JPY2.317 trln) in February. However, the investment flows will be of more interest. The March data showed that Japan investors became net sellers of U.S. bonds (-JPY563 bln) after four straight months of net buying. Japan investors stayed net sellers of both Australian bonds (-JPY158 bln) and Canadian bonds (-JPY163 bln) for the third straight month. Investors stayed net buyers of Italian bonds (JPY109 bln) for the third straight month. Overall, Japan investors became total net sellers of foreign bonds (-JPY731 bln) after two straight months of net buying. Still, it’s still too early to say that Japan investors have stopped chasing higher yields abroad.

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