Dollar Soft as Trade Euphoria Fades

May 13, 2025

Win Thin

Despite the truce, tariffs are still going to have a significant impact
on the U.S. economy; Fed officials seem to recognize these risks; inflation data come into focus; April NFIB small business optimism continues to fall; Brazil central bank publishes the minutes of last week’s meeting
Germany May ZEW survey was mixed; U.K. reported labor market data; BOE easing expectations have been pared back
BOJ published its summary of opinions for its latest meeting; Australia
business and consumer surveys were mixed

The dollar is soft as trade euphoria fades. DXY is trading lower near 101.601 as it becomes apparent that the tariffs will still have a significant impact on the U.S. economy (see below). USD/JPY trading lower near 148.10 and appears to be in a new 145-150 trading range. Elsewhere, the euro is trading higher near $1.1105 and sterling is trading higher near $1.3205. We continue to view any dollar relief rallies with skepticism, which today’s price action would seem to confirm. Easing trade tensions have removed a significant headwind on the dollar over the short-term, but the medium- and long-term impact on the U.S. economy will be seen in the coming weeks and months. A significant trade deal with China will be very difficult to strike over 90 days and the clock is ticking.

AMERICAS

Despite the truce, tariffs are still going to have a significant impact on the U.S. economy. The non-partisan Budget Lab policy research center at Yale estimates that the 2025 tariffs through May 12 (including the effects of the lower rates with China, the deal with the UK, and the recent announced auto tariff rebate) are equivalent to 15.4 percentage point increase in the US average effective tariff rate. This increase would bring the overall US average effective tariff rate to 17.8%, the highest since 1934, and implies a 1.7 ppt short-run increase in US consumer prices, a -0.7 ppt reduction in real GDP over 2025, and a 0.35 ppt rise in the unemployment rate by year-end.

Fed officials seem to recognize these risks. Governor Kugler noted that “Trade policies are evolving and are likely to continue shifting, even as recently as this morning. Still, they appear likely to generate significant economic effects even if tariffs stay close to the currently announced levels.” With regards to the truce, Chicago Fed President Goolsbee said “It is definitely less impactful stagflationarily than the path they were on. Yet it’s three to five times higher than what it was before, so it is going to have a stagflationary impulse on the economy. It’s going to make growth slower and make prices rise.” He stressed that “the bar for action has to be high when there’s so much uncertainty.”
Market expectations have adjusted to last week’s hold by the Fed. The odds of a June cut have fallen below 10%, rising to around 40% in July and fully priced in for September. Looking ahead, the swaps market is pricing in around 75 bp of total easing over the next 12 month, down from 125 priced in last week.

Inflation data come into focus. April CPI will be reported today. Headline is expected to remain steady at 2.4% y/y while core is expected to remain steady at 2.8%. The Cleveland Fed’s Nowcasting model has headline at 2.3% and core at 2.8%. Looking ahead to May, that model has headline at 2.4% and core at 2.8%. Keep an eye on super core (core services less housing), a key measure of underlying inflation. In March, super core inflation fell to four-year low of 2.9% y/y vs. 3.8% in February. Higher tariffs can ultimately derail the disinflationary process.

The disinflationary effect from President Trump’s Executive Order aimed at cutting US drug prices should be muted. Prescription drugs account for 0.937% of the US CPI basket. The broader category of medicinal drugs, which includes both prescription and nonprescription medications, accounts for 1.353% of the CPI basket.

April NFIB small business optimism continues to fall. Headline came in at 95.8 vs. 95.0 expected and 97.4 in March. This was the fourth straight drop to the lowest since October. Looking at the details, 15% of the respondents expect improved business conditions over the next six months, down six ppt from March and also the fourth straight drop. Elsewhere, plans for capital outlays also weakened. The share of respondents expecting to invest in equipment or other big-ticket items fell 3 points to a five-year low. NFIB Chief Economist Dunkelberg noted that “While owners are still trying to fill a high number of current job openings, their outlook on business conditions is less supportive of future business investments.”

Brazil central bank publishes the minutes of last week’s meeting. At that meeting, the bank hiked rates 50 bp to 14.75% and noted that the easing cycle in in an “advanced stage” and that calibration of monetary policy depends on how inflation behaves. The bank warned that risks to the inflation outlook in both directions are higher than usual. As such, “This scenario prescribes a significantly contractionary monetary policy for a prolonged period to assure the convergence of inflation to the target.” The swaps market is pricing in one more 25 bp hike over the next three months that would see the policy rate top out near 15.0%.

EUROPE/MIDDLE EAST/AFRICA

Germany May ZEW survey was mixed. Expectations came in at 25.2 vs. 10.0 expected and -14.0 in April, while current situation came in at -82.0 vs. -77.0 expected and -81.2 in April. German readings have improved in recent weeks but it remains to be seen whether this can be sustained. European Central Bank expectations have fallen. A cut at the next meeting June 5 is nearly priced in. However, the swaps market is pricing in only 50 bp of total easing over the next 12 months that would see the policy rate bottom near 1.75%. GC members Escriva, Makhlouf, and Knot speak today.

U.K. reported labor market data. Unemployment rose a tick as expected to 4.5% in the three-month period ending in March. Weekly earnings ex-bonuses came in a tick lower than expected at 5.6% y/y vs. 5.9% previously, while private earning ex-bonuses came in a tick lower than expected at 5.6% y/y vs. 5.9% previously. Looking ahead to April, payrolled employees fell -33k, the third straight drop. Rising labor market slack points to further progress on disinflation. Indeed, the BOE’s Agents’ pay survey has pay settlements at 3.7% by end-2025 and expectations for wage growth from the DMP survey are around 4% by year-end.

Bank of England easing expectations have been pared back. Last week’s three-way vote split suggests back-to-back rate cuts are unlikely. Indeed, odds of a 25 bp cut in June are around 15%, while the swaps market is pricing in only 50 bp of total easing over the next 12 months, about half of what was expected last week. This latest batch of labor market data support the BOE’s “gradual and careful approach” to further rate cuts. Chief Economist Pill and Governor Bailey speak today.

ASIA

Bank of Japan published its summary of opinions for its latest meeting. At that April 30-May 1 meeting, the bank delivered a dovish hold. One board member said “How US tariff policy will turn out and how firms respond to the policy are both fluid. Therefore, the bank’s outlook for economic activity and prices can only be provisional at this point; it could be revised considerably depending on developments.” One member said “While the Bank of Japan will enter a phase of pausing its policy interest rate hikes with a deceleration in the US economy, it should not be too pessimistic, and it will be required to conduct monetary policy in a nimble and more flexible manner.” In remarks overnight, Deputy Governor Uchida was likewise cautious. While he reiterate the bank’s intent to continue tightening if its economic outlook is realized, Uchida said uncertainties are “extremely high.” The BOJ is still seen on hold through 2025. Looking ahead, the swaps market is pricing in 25 bp of tightening over the next 12 months.

Australia business and consumer surveys were mixed. NAB April Business confidence rose 2 points to -1 but remains below its long run average. Meanwhile, business conditions eased 2 points to +2, driven by a fall in profitability. Trading conditions eased slightly, and employment intentions were steady. Elsewhere, the Westpac-Melbourne Institute Consumer Sentiment Index rose 2 points to 92.1 in May but remains below its long run average of 100.4. Encouragingly, the ‘economic outlook, next 12 months’ sub-index rose 2.8% to 93, above the long-run average of 90.6. The market continues to fully price in a 25 bp cut to 3.85% at the May 20 policy meeting, while the swaps market is pricing in nearly 100 bp of total easing over the next 12 months.

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