Dollar Lost in Translation

US

USD is trading on the defensive and 10-year Treasury yields are down 13bps from yesterday’s high of 4.56%. As we suspected, the ripple effect on Treasuries of Moody's Ratings downgrade would be contained. Financial markets will ignore the May Philadelphia Fed non-manufacturing index (1:30pm London).

Fed officials are sticking to the no hurry to resume easing script. Atlanta Fed President Raphael Bostic noted policymakers would need to wait “three to six months” to see how things settle adding he’s “leaning much more into one rate cut this year.” Fed Vice Chair Philip Jefferson reiterated “it is appropriate that we wait and see how the policies evolve over time and their impact.” New York Fed President John Williams highlighted that the Fed can take its time assessing new data. Fed funds futures continue to imply over 90% odds that the next 25bps cut will be at the September 17 FOMC meeting.

Nevertheless, wider US-G6 2-year bond yield spreads is not supporting a firmer USD. This suggests financial markets are losing confidence in US policies. In our view, the fundamental backdrop remains difficult for USD for three reasons: (i) the Trump administration implicitly supports a weaker dollar, (ii) the US economy faces stagflation risk, and (iii) US policy credibility has been undermined by the trade war.

G7 finance ministers and central bank governors meet today until Thursday in Banff, Canada. According to a statement from the US Department of the Treasury, Secretary Scott Bessent will focus on “the need to address global economic imbalances and non-market practices in both G-7 and non-G7 countries...” As such, there is a risk that the post-meeting communique tweaks the language on currency policy.

AUSTRALIA

RBA delivers a dovish cut. AUD is underperforming and Australian bonds are outperforming. Cash rate futures added an extra 25bps of cuts, totaling 75bps of easing over the next 12 months. Still, we expect AUD/USD to hold above 0.6350-0.6400 on broad USD weakness.

As was widely anticipated, the RBA cut the cash rate target 25bps to 3.85%. However, the RBA unexpectedly lowered the bar for more easing. First, the RBA stressed that “Inflation is in the target band and upside risks appear to have diminished.” Second, the RBA trimmed GDP growth and inflation forecasts across most of the projection horizon (see table below). Third, RBA Governor Michele Bullock said the rate cut discussion was between 50bps or 25bps.

CANADA

CAD will take its cue today from the Canada’s April CPI (1:30pm London). Headline CPI is expected at 1.6% y/y vs. 2.3% in March while core CPI (average of trim and median CPI) is anticipated at 2.85% y/y vs. 2.85% in March. The Bank of Canada (BOC) projects headline inflation to average 1.5% over Q2 under both of its scenario analysis. Easing inflation pressures leaves room for the BOC to deliver the 50bps of cuts priced-in by the swaps market.

We still expect AUD/CAD to edge higher to 0.9500. First, the US and China took significant steps to de-escalate their trade war. Second, any trade agreement between the US and Canada are bound to include higher tariffs which will have negative consequences on Canada’s economy. The BOC’s scenario analysis shows Canada’s real GDP growth either stalling in Q2 or contracting over the remainder of 2025.

UK

EUR/GBP is consolidating near recent lows just above 0.8400. Yesterday, the UK and EU struck a post-Brexit deal covering food, fishing, defense, and youth mobility. The deal is projected to boost the UK economy by 0.3% (£9 billion) by 2040, which will do little to offset the costs of Brexit on the UK economy. The UK Office of Budget Responsibility estimates the cost of Brexit on the UK economy to be between 4% and 5% of GDP.

Instead, the main potential economic value to the UK of warmer ties with the EU lies in a brighter business investment outlook by reducing regulatory complexity. Bottom line: the BOE’s cautions easing cycle, the US-UK trade deal, and closer UK-EU relations suggest EUR/GBP can sustain a break below its 200-day moving average at 0.8387.

CHINA

USD/CNH is up near its 200-day moving average at 7.2239. As was widely expected, China commercial banks trimmed the 1- and 5-year Loan Prime Rates (LPR) by 10bps to 3.00% and 3.50%, respectively. The cut tracks the 10bps reduction in the People's Bank of China (PBOC) policy-relevant 7-day reverse repo rate earlier this month. In our view, more policy easing and fiscal reforms that lead households to gain a greater piece of the economic pie are necessary to support growth.