Cool the Sparks

May 12, 2025
6 min read
  • The US and China have de-escalated their trade war. USD is firm near a one month high while CNH rallied. Global stocks and bond yields are up.
  • The Fed is in no hurry to resume easing. USD has entered a short-term period of consolidation, but fundamental backdrop remains challenging.
  • No policy-relevant economic data releases today. Check-out our Drivers for the Week for an in-depth look at what markets are facing this week.

Cool the Sparks

US

USD is firm near a one month high. China-proxy currencies (AUD and NZD) are outperforming while safe haven currencies (JPY and CHF) are underperforming as the US and China have de-escalated their trade war.

Both the US and China saw “substantial progress” in weekend trade talks. Treasury Secretary Bessent said the US will share further details today and Chinese Vice Premier He Lifeng promised a joint statement. CNH rallied against most currencies on speculation Chinese authorities will allow the renminbi to appreciate as part of a possible trade deal with the US.

USD has entered a short-term period of consolidation as the Fed is in no hurry to resume easing. Fed Chair Jay Powell reiterated last week “we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.” Up next is Fed Governor Adriana Kugler (3:25pm London). Kugler noted on Friday that “Overall we see health still in the real economy, so that gives us time to make sure that we continue to make progress on inflation, and we keep our inflation expectations very well anchored.”

Nonetheless, the fundamental backdrop remains difficult for USD: the Trump administration implicitly supports a weaker dollar, the US economy faces stagflation risk, and US policy credibility has been undermined by the trade war.

JAPAN

JPY is underperforming on improving financial market risk sentiment. Still, protectionist trade policies remain a major drag to global growth and limits JPY downside. Japan’s balance of payments backdrop is JPY supportive especially during periods of heightened risk aversion. Japan’s current account surplus widened to a record of ¥30.3tn in the 12 months to March (4.9% of GDP) vs. ¥29.8tn in February.

UK

GBP/USD is trading near the lower end of its one month 1.3200-1.3440 range. EUR/GBP is consolidating near its lowest level since early April around 0.8450. The Bank of England’s (BOE) cautions easing cycle, the US-UK trade deal, and warmer UK-EU relations bode well for GBP versus EUR.

We hear today from a handful of BOE MPC members: Deputy Governor Clare Lombardelli (9:00am London), Megan Green (11:30am London), Catherine Mann (1:50pm London), and Alan Taylor (5:00pm London). At last week’s meeting, the MPC voted by a majority of 5-4 to reduce the policy rate 25bps to 4.25%. Two members preferred to reduce rates by 50bps (Taylor and Dhingra) and two members preferred to keep rates unchanged (Mann and Pill). The three-way vote split suggests back-to-back rate cuts are unlikely.

EUROZONE

EUR/USD is trading near a one month low just above 1.1200. Easing ECB rate cut expectations offers EUR support. ECB Executive Board member Isabel 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 25bps rate cut to 2.00% at the next ECB meeting June 5 is fully priced in. However, the swaps market is pricing in about 50bps of total easing over the next 12 months, down from nearly 75bps earlier this month.

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