The dollar remains firm ahead of the weekend. DXY is trading higher near 97.732 despite ongoing tariff noise as Trump announced more tariffs on Canada (see below). Given the ongoing arbitrary nature of US tariff policies, we believe confidence in US policymaking will continue to erode. The euro is trading lower near $1.1695 while sterling is underperforming after weak GDP data and is trading lower near $1.3540. Elsewhere, USD/JPY is trading higher near 146.80 after two straight down days. While the dollar had been enjoying a small measure of stability this week, we believe the fundamental dollar downtrend remains intact. The economy is slowing and more Fed officials are tilting dovish (see below). Haphazard tariff policy will extend the current period of uncertainty, while higher tariffs clearly raise stagflation risks, which is also dollar-negative. Similar to what we saw during Liberation Day, this latest round of tariff noise should herald the next leg down in the dollar.
AMERICAS
President Trump hit Canada with new tariffs. Trump said the US will impose a tariff of 35% on Canadian goods starting August 1, adding that “If for any reason you decide to raise your Tariffs, then, whatever the number you choose to raise them by, will be added onto the 35% that we charge.” A US official later specified that the 35% tariffs will only apply to imports not covered by the United States-Mexico-Canada Agreement (USMCA). In our view, the new tariff threat is likely a pressure tactic aimed at securing a US-Canada trade deal ahead of the self-imposed July 21 deadline.
The split at the Fed may be widening. Musalem said “It’s going to take time for the tariffs to settle. There’s a scenario where we could be in Q4 this year, or Q1 or Q2 of next year where tariffs are still working themselves into the economy.” On the other hand, Daly seems to be tilting more dovish as she raised the possibility that tariffs “just doesn’t materialize to a large increase in price inflation for consumers because the businesses find ways to adjust.” Daly added “I see two cuts as a likely outcome.” Lastly, Governor Waller doubled down on his call for a July rate cut pointing out that “Inflation has come down far enough to justify a move - and tariffs should necessarily not be a reason to delay.” Odds of a September cut remain around 70% and October is now fully priced in. Looking ahead, the swaps market is pricing in 100 bp of easing over the next 12 months after briefly touching 125 bp last week.
Governor Waller got pretty specific about his view on the Fed balance sheet. While most Fed officials remain non-committal about the optimal size, Waller said the Fed should be able to lower the level of bank reserves to around $2.7 trln from the current $3.2 trln. He estimated that would put the overall balance sheet at $5.8 trln vs. the current $6.7 trln. Recall that Waller was the only dissent to slowing the pace of balance sheet runoff at the March 18-19 FOMC meeting. Since April 1, the Fed is allowing up to $5 bln (down from $25 bln) of USTs and $35 bln (unchanged) of MBS to mature each month without reinvesting the returned principal. Under the current ample reserves policy, the optimal size of the Fed’s balance sheet is unknown. Instead, the Fed will have to continually look for signs of stress in the funding markets, like we saw in the summer of 2019.
Weekly jobless claims data suggest the labor market continues to hold up relatively well. Initial claims came in at 227k vs. 235k expected and a revised 232k (was 233k) the previous week. As a result, the 4-week moving average fell to 236k vs. 241k the previous week. Elsewhere, continuing claims came in as expected at 1.965 vs. a revised 1.955 mln (was 1.964 mln) the previous week. Of note, next week’s initial claims reading will be for the BLS survey week containing the 12th of the month. There is no Bloomberg consensus yet for July NFP but its whisper number stands at 120k vs. 147k in June. Given underlying signs of weakness in the June NFP and other indicators, we suspect that 120k is a tad optimistic.
The growth outlook is deteriorating. The New York Fed Nowcast model now estimates Q2 growth at 1.6% SAAR vs. 1.7% the previous week and Q3 at 1.8% SAAR vs. 1.9% the previous week. This model will be updated today. Elsewhere, the Atlanta Fed GDPNow model still estimates Q2 growth at 2.6% SAAR vs. 2.5% previously. This model will be updated next Thursday. These latest readings aren't bad but are decelerating after weeks of strength.
Canada highlight will be June jobs data. Consensus sees flat job creation vs. 8.8k in May. The unemployment rate is expected rise a tick to near a four-year high of 7.1%. Regardless, sticky underlying inflation in Canada suggests the bar for additional Bank of Canada rate cuts is high. The swaps market is pricing in around 30% odds of a 25 bp cut at the next meeting July 30 and around 25 bp of total easing over the next 12 months that would see the policy rate bottom near 2.50%.
EUROPE/MIDDLE EAST/AFRICA
European Central Bank officials are split. Executive Board member Schnabel “The bar for another rate cut is very high. There would only be a case for another rate cut if we saw signs of a material deviation of inflation from our target over the medium term. And at the moment, I see no signs of that.” On the other hand, Governing Council member Panetta was more equivocal and said “If downside risks to growth were to strengthen disinflationary trends, it would be appropriate to continue with monetary easing.” The market sees basically no odds of a cut at the next meeting July 24 and only 25 bp of total easing over the next 12 months.
U.K. reported weak May real sector data. GDP unexpectedly contracted for the second straight month at -0.1% m/m vs. 0.1% expected and -0.3% in April. IP was the main drag to growth at -0.9% m/m vs. -0.1% expected and -0.6% in April, while construction output contracted -0.6% vs. 0.2% expected and a revised 0.8% (was 0.9%) in April. Services output increased 0.1% as expected after falling a revised -0.3% (was -0.4%) in April. Sluggish UK GDP growth, labor market slack emerging, and the likelihood of higher taxes could force the BOE to cut the policy rate more aggressively than anticipated. The swaps market is pricing in 90% odds of an August cut and 75 bp of total easing over the next 12 months. In contrast, the ECB’s rate-cutting phase is close to wrapping up. As such, EUR/GBP has room to edge higher towards 0.8800.
ASIA
Secretary of State Rubio said a Xi-Trump summit is likely. The comments came after Rubio met Foreign Minister Wang Yi at the ASEAN summit in Malaysia. The timing couldn’t be better, as the 90-day truce between the two nations ends in early August. Given the lack of any real trade deals since Liberation Day, we do not expect any significant developments to emerge anytime soon. That said, markets seem fine with an uneasy truce, as opposed to open hostilities.
Reports suggest JPMorgan is considering cutting China and India weights in its indexes. Specifically, the bank is asking for feedback from clients on possible changes to its GBI-EM Global Diversified index. One of the proposals would lower the cap on individual countries from 10% to 8.5%. Note that these are preliminary proposals. In a consultation last year, JPMorgan initially proposed a methodological change that would have resulted in China’s index share falling to 6%, but later withdrew the proposal. Of note, Chinese bonds were added to JPMorgan indexes in 2020 while Indian bonds were added in 2024. Furthermore, reports suggest JPMorgan is also previewing a new index for local Frontier bonds.
