The dollar remains under pressure. DXY is trading lower for the second straight day near 100.317. in the absence of any key data, the dollar remains vulnerable to more downside this week. AUD is the worst performing major after the dovish RBA cut (see below). USD/JPY traded as low as 144.10 before rebounding to 144.55 currently as JGB yields continue to rise (see below). Elsewhere, the euro is trading flat near $1.1245 and sterling is trading flat near $1.3365 after the EU-UK deal on food, fishing, and defense was announced (see below). We continue to view any dollar relief rallies with skepticism. Easing trade tensions have removed a significant headwind on the dollar over the short-term, but those tensions are likely to pick up over the next few weeks as new (and higher) tariffs are announced. Even a resolutely hawkish Fed has done little to help the greenback (see below). Lastly, the Moody’s downgrade has raised concerns about forced UST selling in Hong Kong (see below).
AMERICAS
G-7 finance ministers and central bank governors meet today in Banff, Canada. The meetings will run through Thursday. According to a statement from the Department of the Treasury, Secretary 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. If so, the changes are likely to fit into market perceptions that the U.S. wants other currencies to strengthen vis a vis the dollar.
The Fed is clearly on an extended hold. Bostic said “Given the trajectory of our two mandates, our two charges, I worry a lot about the inflation side, and mainly because we’re seeing expectations move in a troublesome way.” He said “I’m leaning much more into one cut this year because I think it will take time,” adding “I think we’ll have to wait three to six months to start to see where this settles out.” Williams said “It’s not going to be that in June we’re going to understand what’s happening here, or in July. It’s going to be a process of collecting data, getting a better picture, and watching things as they develop.” This patience is probably the right view. If we get new tariff rates over the next 2-3 weeks, they won't impact the data for a couple months and so a June 18 or July 30 cut seem highly unlikely (around 10% and 35% odds, respectively). Even a cut September 17 is not fully priced in (95% now). Bostic, Barkin, Collins, Musalem, Kugler, Hammack, and Daly all speak today.
Wider US 2-year yield spreads are not supporting a firmer USD. This supports our view that financial markets are losing confidence in US policies. In our view, the fundamental backdrop remains difficult for USD for three reasons: 1) the Trump administration implicitly supports a weaker dollar, 2) the US economy faces stagflation risk, and 3) US policy credibility has been undermined by the trade war.
Canada highlight will be April CPI data. Headline is expected at 1.6% y/y vs. 2.3% in March, while core median is expected to remain steady at 2.9% y/y and core trim is expected to remain steady at 2.8% y/y. The Bank of Canada projects headline inflation to average 1.5% over Q2 under both of its scenario analysis. Recall that under scenario one, GDP stalls briefly in Q2 due to trade policy uncertainty. This scenario assumes that most tariffs imposed since the trade conflict began are negotiated away, but the process is unpredictable. Under scenario two, GDP contracts over the next year due to tariffs and the adverse effects of uncertainty. This scenario assumes a long-lasting global trade war unfolds. Odds of cut at the next meeting June 4 are around 70%, while the swaps market is pricing in 50 bp of total easing over the next 12 months.
EUROPE/MIDDLE EAST/AFRICA
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% (GBP9 bln) 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.
The European Central Bank sees financial stability risks from the trade war. Ahead of the full report tomorrow, the bank released a shorter note that said escalating trade tensions have emerged as a “significant concern” for financial stability and warned “Policy authorities need to identify the risks stemming from trade tensions, monitor them and evaluate their potential impact on financial stability.” The ECB recommended that “financial institutions should also take a number of proactive steps to cope with risks stemming from trade tensions.” We concur.
Some Bank of England officials remain hawkish. Chief Economist Pill said “My dissenting vote stems from a concern that the pace of withdrawal of monetary policy restriction since last summer – quarterly cuts of 25 basis points – is too rapid given the balance of risks to price stability we face. This is in line with my preference for ‘cautious and gradual’ cuts in Bank Rate expressed over the past twelve months.” He stressed that he was in favor of a skip rather than a halt. Recall Pill and Mann dissented this month in favor of steady rates. Odds of a 25 bp cut in June are around 10%, while the swaps market is pricing in around 50 bp of total easing over the next 12 months.
Nigeria central bank is expected to keep rates steady at 27.5%. At the last meeting February 20, the central bank kept rates steady for the first time since March 2022. Over that tightening cycle, the bank hiked rates from 11.50% to 27.50% currently even as inflation rose from 15.9% y/y in March 2022 to peak at 34.6% y/y in November 2024. April headline inflation came in at 23.7% y/y vs. 24.2% in March, with progress showing signs of leveling off. Since inflation remains somewhat elevated, another hold seems likely.
ASIA
JGB yields continue to climb. Concerns about demand are picking up after the weak results at the 20-year auction today. These concerns arose even as reports emerged that the Bank of Japan will meet with market participants to help gauge how to adjust its bond-buying program. Two meetings will be held with the sell-side and one with the buy-side. The bank will then use these findings to review its bond-buying operations at the next policy meeting June 16-17. With the JGB market already getting skittish, there will be great pressure on the BOJ to get its messaging right next month.
Reserve Bank of Australia cut rates 25 bp to 3.85%, as expected. 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 its growth and inflation forecasts across most of the projection horizon (see below). Third, Governor Michele Bullock said the rate cut discussion was between 50 bp or 25 bp. Given this dovish stance, the market is pricing in an additional 25 bp of easing over the next 12 months, or 100 bp total. Still, we expect AUD/USD to hold above 0.6350-0.6400 on broad USD weakness.
U.S.-China tensions remain in play. After warning last week that such a move breached U.S. export controls, the Commerce Department changed its language to say that using Huawei’s Ascend chips “risks” violating export controls. Beijing issued a statement Monday noting it had “negotiated and communicated with the US at all levels through the China-US economic and trade consultation mechanism, pointing out that the US’s actions seriously undermined the consensus reached at the high-level talks between China and the US in Geneva.” It asked the U.S. to “correct its mistakes.” Bottom line: don’t expect a U.S.-China trade deal anytime soon.
Hong Kong asset managers are concerned about forced selling of USTs. Funds operating under the Mandatory Provident Fund system are limited to holding only 10% of their assets in USTs if the U.S. no longer has AAA rating from an approved rating agency. After the Moody’s downgrade, only Japan’s Rating & Investment Information gives the U.S. that top rating. Reports suggest the Hong Kong Investment Funds Association has asked the Mandatory Provident Fund Schemes Authority and the Financial Services and the Treasury Bureau to make an exception. Regulatory official confirmed that the U.S. still has one AAA rating and added that it “will closely monitor the latest market developments and take appropriate actions to safeguard the interest of MPF scheme members as and when necessary.” Stay tuned.
