• USD rally is not sustainable. US policymaking credibility is increasingly under threat and the US economy is showing cracks.

• We see no strong dollar bias in this week’s main US economic data releases.

• BOE widely expected to slash rates 25bps to 4.00%. The focus will be on the vote split, updated economic projections, and review of the pace of gilt runoff.

A Rally Built on Shaky Ground

USD rallied last week to a two-month high amid concerns the US-EU trade agreement would hurt the Eurozone economy and Fed Chair Jay Powell doubling down on the guidance that the FOMC is in no hurry to resume easing. Powell noted that “policy should be a little bit restrictive, somewhat restrictive, because we want inflation to move all the way back to its target.”

USD pared back some its gains on Friday following a surprisingly poor US employment report. In July, the increase in non-farm payrolls fell short of expectations (actual: 73k, consensus: 104k). Gains were largely driven by the noncyclical health care and social assistance sectors, underscoring mounting fragility in the labor market.

Alarmingly, the previous two months payrolls data were revised down by a staggering -258k, the most since May 2020. This means payrolls have risen by an average of only 35k/month the last three months, well below the breakeven pace of job gains (80-100k) needed to keep the unemployment rate stable. Indeed, the unemployment rate rose in line with consensus to 4.2% vs 4.1% in June, but the 0.1pts drop in the participation rate to 62.2% suggests the labor market is losing both breath (fewer people engaged) and strength (more people unemployed).

USD is vulnerable to more downside:

First, US policymaking credibility is increasingly under threat. President Donald Trump actively pushing Fed Chair Powell to “substantially” lower rates undermines the Fed’s independence. Fed Governor Adriana Kugler’s departure on August 8, gives President Trump an opportunity to appoint a replacement aligned with his monetary policy agenda. Meanwhile, the dismissal of the Bureau of Labor Statistics head by President Trump immediately after the July jobs number risks damaging perception of US economic data integrity.

Second, the US economy is showing cracks as tariff pressures mount. Final sales to private domestic purchasers, the sum of consumer spending and gross private fixed investment, slowed at an annualized rate of 1.2% in Q2 vs. 1.9% in Q1. This was the slowest pace since Q4 2022 and well below long-term trend of around 3%. Weaker labor market conditions point to worsening consumer spending activity.

Moreover, the ISM manufacturing index unexpectedly dropped a full point in July to a 9-month low at 48.0 (consensus: 49.5), indicative of a deeper contraction in the manufacturing sector. In parallel, progress towards the Fed’s 2% inflation goal is stalling as core PCE printed at 2.8% y/y for a second consecutive month in June.

We see no strong dollar bias in this week’s main US data releases. The ISM services index is expected to improve in July (Tuesday), the trade deficit is projected to narrow in June (Tuesday), and non-farm productivity is seen recovering in Q2 after contracting the previous quarter (Wednesday).

BOE Poised to Cut Rates

Stagflation headwinds in the UK threaten further GBP weakness versus EUR. On Thursday, the Bank of England (BOE) is widely expected to cut the policy rate 25bps to 4.00% and reiterate its guidance for “a gradual and careful approach” to further rate cuts. UK real GDP contracted in April and May, but stubbornly high UK underlying inflation will keep the BOE cautious.

The focus will be on the Monetary Policy Committee (MPC) vote split, and Monetary Policy Report (MRP). At the last June 19 meeting, the MPC voted by a majority of 6-3 to keep rates on hold. Taylor, Dhingra, and Ramsden preferred to reduce the Bank Rate by 25bps. The risk is one of these three members opts for a 50bps cut.

The MPR will include fresh economic projections and a formal review of the past year’s quantitative tightening (QT). Between October 2024 to September 2025, the BOE will have reduced its holdings of gilts by £100bn to £558 bn. The BOE is expected to flag that it plans to slow the pace at which it shrinks its bond holdings. Maintaining the current £100bn pace of gilt runoff over the next 12 months would force the BOE to sell a record £51bn of gilts, given the smaller volume of maturing bonds, and risk pushing up long-term gilt yields.

Japan Pay Rises Won’t Stoke Inflation

USD/JPY is back trading within our wide 142.00-150.00 range after briefly overshooting to near 151.00 last week. Japan June cash earnings is the data highlight (Tuesday). Nominal cash earnings are expected at 3.0% y/y vs. 1.4% in May reflecting the outcome of this year's annual spring labor-management wage negotiations. The less volatile scheduled pay growth for full-time workers is forecast at 2.5% y/y vs. 2.4% in May. Overall, Japan wage growth is not a source of significant inflation pressures given annual total factor productivity growth of about 0.7%.

Bottom line: the Bank of Japan is unlikely to raise the policy rate by more than is currently priced-in, limited JPY upside. The swaps market price-in 60% odds of a 25bps rate hike by year-end and a total of 50bps of rate increases to 1.00% over the next two years.

Swiss Inflation: Keeping It Cool

USD/CHF downtrend intact. Swiss headline and core CPI are expected to print for a second straight month at 0.1% y/y and 0.6% y/y in July, respectively (Monday). The Swiss National Bank (SNB) forecasts headline CPI inflation to average 0.1% in Q3 before gradually picking-up and stabilizing at 0.7% by Q2 2027.

At the last June 19 meeting, the SNB cut the policy rate 25bps to 0%. Benign inflation pressures and plans by the US to impose a 39% tariff (up from an initial 31% proposal) on Swiss goods from August 7 mean a negative policy rate cannot be ruled out. The swaps market price-in 60% probability of 25bps cut in the next 12 months. Nevertheless, CHF safe haven status outweighs the drag to the currency from the likelihood of negative rates.

Sweden Inflation to Dampen Odds of Further Cuts

SEK face upside risk as there is room for the swaps curve to slash bets of a 25bps Riksbank policy rate cut to 1.75% over the next 12 months. The policy relevant CPIF is expected to rise to an 18-month high at 3.1% y/y vs. 2.8% in June while CPIF ex-energy is projected at 3.2% y/y vs. 3.3% in June (Thursday). If so, both headline and core CPIF would be tracking well above the Riksbank’s July forecast of 2.5% and 2.8%, respectively.

Canada July Jobs Report: A Test of Resilience

USD/CAD will likely settle back within a 1.3600-1.3700 range this week. The pace of job gains is expected to slow sharply to 10k in July (Friday) after soaring by 83.1k in June, strengthening the case for a 25bps cut by year-end (80% priced-in).

Canada’s June labor force survey was strong but masked weakness in sectors that rely on US trade. These include several manufacturing and transportation subsectors as well as commodities sectors, including energy and forestry. Together, these subsectors make up about 10% of employment and face further strain from higher tariffs. As of August 1, the US increased the tariff on Canadian goods imports not covered by the United States-Mexico-Canada Agreement (USMCA) from 25% to 35%.

At its July 30 meeting, the Bank of Canada (BOC) kept the policy rate at 2.75% (widely expected) and left the door open to more easing. The BOC warned that “If a weakening economy puts further downward pressure on inflation and the upward price pressures from the trade disruptions are contained, there may be a need for a reduction in the policy interest rate.” Canada’s July CPI print, due August 19, will be a key driver of near-term BOC rate expectations.

Kiwi Jobs to Slip in Q2

NZD faces some headwinds this week. New Zealand’s Q2 labor market data (Tuesday) will likely bolster the case for additional RBNZ policy rate cuts. New Zealand employment is expected at -0.1% q/q vs. 0.1% in Q1, whereas the RBNZ has penciled in a 0.2% increase. The unemployment rate is expected to rise 0.2pts to 5.3% (highest since Q4 2016) versus the RBNZ forecast of 5.2%. Private wages are anticipated at 0.5% q/q versus 0.4% in Q1, marginally lower that the RBNZ 0.6% projection.

Over the next 12 months, the swaps market price-in nearly 40bps of easing and the policy rate to bottom between 2.75% and 3.00%. The US plan to impose a 15% tariff (up from an initial 10% proposal) on New Zealand goods from August 7 sharpens the case for looser monetary policy. The next RBNZ policy rate decision is August 20, and a 25bps cut to 3.00% is currently 84% priced-in.