Dollar Steadies as New Week Begins

February 24, 2025

Win Thin

More cracks are appearing; Fed officials may find themselves in a policy dilemma; Chicago Fed NAI for January will be the highlight; Mexico reports mid-February CPI
There’s a new chancellor in town; an ECB official finally acknowledged the possibility of moving policy to accommodative; February German IFO business climate survey was mixed; BOE speakers will be plentiful; Israel is expected to keep rates steady at 4.50%
New Zealand reported solid Q4 retail sales data

The dollar has steadied as the new week begins. DXY is trading flat near 106.650 and has hung on to its risk off gains from Friday. However, JPY and CHF are underperforming as market sentiment improves. USD/JPY is trading back near 150 after trading below 149 earlier today. The euro is trading flat near $1.0470 after giving up earlier post-election gains (see below), while sterling is trading flat near $1.2640. Recent softness in the U.S. data is concerning (see below), but we are not ready to push the panic button yet. If the data continue to soften, however, the strong USD fundamentals of strong growth, elevated inflation, and a more hawkish Fed will be called into question (see below). We’re not there yet, but the lack of any topline U.S. data until Friday is likely to keep markets nervous and choppy.

AMERICAS

More cracks are appearing. After the shockingly weak January retail sales data, last week brought very weak February data, with preliminary PMIs and consumer confidence plunging sharply. Taken alone, each of these data points could be shrugged off. Taken together, a more worrisome view of the U.S. economy is starting to emerge. The unpredictability of the Trump administration policies has undoubtedly impacted the business sector in terms of delayed investment and hiring, but it now appears that consumers are reacting too. Another month or two of poor US economic data would deliver a blow to the U.S. exceptionalism narrative and is a downside risk for USD. Stay tuned.

Fed officials may find themselves in a policy dilemma. Virtually every Fed official has expressed confidence that inflation will eventually fall to the 2% target. The firm U.S. data have allowed the Fed to remain patient and keep policy restrictive until this happens. Can they remain patient if the economy weakens significantly? We believe the Fed will have to start acknowledging the growing risks to the economic outlook if the data continue to soften and convey to the markets how this may affect monetary policy. Two cuts are still priced in but the timing has been moved forward to July and Q1 2026. This is not recession pricing and so the markets (like us) are in wait and see mode.

Chicago Fed National Activity Index for January will be the highlight. Headline is expected at -0.05 vs. 0.15 in December. If so, the 3-month moving average would rise to 0.03 vs. -0.13 in December. It would also be the highest since October 2022 and further above the -0.7 threshold that typically signals recession.

February Fed regional surveys will continue rolling out. Dallas Fed manufacturing will be reported today and is expected at 6.4 vs. 14.1 in January. Philly Fed services, Richmond Fed manufacturing (-3 expected) and services, and Dallas Fed services will all be reported tomorrow. So far, the February manufacturing surveys have come in firm.

Mexico reports mid-February CPI data. Headline is expected at 3.77% y/y vs. 3.48% previously, while core is expected at 3.61% y/y vs. 3.61% previously. If so, headline would accelerate for the first time since October but would remain within the 2-4% target range. Minutes of the February 6 meeting were dovish, which was no surprise given the 50 bp cut that was delivered then. The bank said it would consider weak economic activity in future policy decisions, adding that another 50 bp cut can be considered at the next meeting March 27. The swaps market is pricing in another 150 bp of easing over the next 12 months that would see the policy rate bottom near 8.0%.

EUROPE/MIDDLE EAST/AFRICA

There’s a new chancellor in town. Friedrich Merz is set to be new German chancellor as his center-right Christian Democratic Union (CDU) captured the highest proportion of votes in Sunday’s election. The CDU/CSU bloc won 28.6% of the votes, equivalent to 208 seats in the 630 seat Bundestag. The populist Alternative for Germany (AfD), led by Alice Weidel, came second with a 20.8% share of the vote (152 seats). Outgoing Chancellor Olaf Scholz’s center-left Social Democratic Party (SPD) placed third with 16.4% (120 seats). Merz said he wanted to form a coalition within the next two months. His party’s solid win paves the way for a two-party coalition. The most likely option is a “grand coalition” with the SPD as Merz has repeatedly ruled out forming a government with AfD. But in politics promises are made of glass.

The election result was in line with polls and is EUR supportive. A two-party coalition will have a good mandate to push through long overdue fiscal reforms more effectively than under a three-party collation. Moreover, AfD does not have enough seats in the Bundestag to block constitutional changes like relaxing the debt brake - which restricts annual structural deficits to 0.35% of GDP in any fiscal year. Any change to the constitution requires two-thirds majorities in both houses of parliament.

A European Central Bank official finally acknowledged the possibility of moving policy to accommodative. GC member Wunsch said he was “relatively comfortable” with market expectations of 2% rates by year-end “give or take 50 basis points.” However, he added that "The other question is whether we need to maintain a restrictive stance, move to neutral, or even become slightly supportive,. If inflation falls fast enough and economic weakness persists, we may need to be a bit supportive here." The swaps market sees the policy rate bottoming at 2%. The ECB clearly has scope to deliver on rate cut expectations, but we remain perplexed why so many ECB officials are viewing the neutral rate as a floor. Rarely do major central bank easing cycles end at neutral.

February German IFO business climate survey was mixed. Current assessment came in at 85.0 vs. 86.3 expected and a revised 86.0 (was 86.1) in January, while expectations came in at 85.4 vs. 85.0 expected and a revised 84.3 (was 84.2) in January. As a result, the headline was flat at 85.2 vs. 85.8 expected. IFO President Fuest noted that “People are holding back investment, people are holding back spending because there is a lack of trust. So if the coalition negotiations do not last too long, and if the new government comes up with an agenda that inspires confidence, the situation could change in the second half of the year.” German GfK consumer confidence for March will be reported Wednesday and is expected at -21.6 vs. -22.4 in February.

There are no major U.K. data releases today but Bank of England speakers will be plentiful. Lombardelli, Ramsden, and Dhingra all speak today. Dhingra was one of the two dissents (Mann was the other) that voted for a 50 bp cut in February and so her comments will clearly lean dovish. The Bank of England is expected to pause at its March 20 meeting. However, the swaps market is pricing in 50 bp of easing over the next 12 months, with some odds of an additional 25 bp cut beyond that.

Bank of Israel is expected to keep rates steady at 4.50%. At the last meeting January 6, the bank also kept rates steady and Governor Yaron said that “To lower rates now would be similar to trying to take out a fire using fuel. Because labor shortages are a major obstacle, lowering rates will increase demand without increasing supply, so it will just bring on price rises.” However, it was ultimately a dovish hold as the updated rate path saw the policy rate at 4.0-4.25% in Q4 2025 vs. 4.5% seen in 3Q 2025 at the October 9 meeting. It appears that the bank is teeing up the start of an easing cycle late this year. The swaps market is pricing in 25 bp of easing over the next six months followed by another 50 bp over the subsequent six months that would see the policy rate bottom near 3.75%.

ASIA

New Zealand reported solid Q4 retail sales data. Real retail sales came in at 0.9% q/q vs. 0.5% expected and a revised 0.0% (was -0.1%) in Q3, with growth across most industries. The data support the RBNZ’s guidance for a more gradual pace of easing. The bank has penciled in another 75 bp of easing over the next 12 months that would see the policy rate bottom at 3.00%. This seems about right. However, the swaps market is a little more hawkish and sees the rate bottoming near 3.25%.

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