The dollar is slightly firmer as markets brace for more hostilities between Israel and Iran. Oil prices are higher on the day, equity markets are lower, UST yields are lower, and gold is higher. DXY is trading back above 98 but remains heavy. The euro is trading flat near $1.1565 while sterling is trading lower near $1.3560. Elsewhere, USD/JPY is trading flat near 144.70 after the BOJ delivered the expected hold (see below). With President Trump warning Tehran to evacuate (see below), we remain one headline away from a deeper risk off episode. While the dollar is seeing a modest haven bid, we believe the fundamental dollar downtrend remains intact. With recent data coming in soft, we expect the Fed to deliver a dovish hold tomorrow (see below). Furthermore, we do not expect any significant trade deals to emerge from the G-7 summit and so tariff uncertainty should also continue to weigh on the greenback.
AMERICAS
Markets are back in risk off mode. There was a brief period of optimism yesterday after reports that Iran was seeking to de-escalate. Instead, markets are braced for further hostilities after President Trump said that “Everyone should immediately evacuate Tehran” while reiterating that Iran “should have signed” the deal he told them to sign. Trump left the G-7 summit early, which White House Press Secretary Leavitt said was “so he can attend to many important matters,” adding that it was due to “what’s going on in the Middle East.”
A major trade deal remains elusive. Japan Prime Minister Ishiba said “There are still some points on which the two sides are not on the same page, so we have not yet reached an agreement on the trade package.” Ishiba added that “We will continue to actively coordinate with the United States to reach an agreement that is beneficial for both countries, without sacrificing Japan’s national interests.” This supports our belief that while some minor deals or frameworks may be announced, the big three of China, EU and Japan are far from any deal with the US. Prime Minister Carney said that Canada and the US “agreed to pursue negotiations toward a deal within the coming 30 days.” We do not expect anything specific to emerge from the G-7 summit about FX except the usual boilerplate language.
The two-day FOMC meeting starts today and ends tomorrow with an expected hold. Given recent inflation data showing little tariff pass-through so far as well as signs of weakening in the labor market, we look for a dovish hold as the Fed prepares the markets for a possible cut in Q3. We expect the statement to soften its previous assessment “that the risks of higher unemployment and higher inflation have risen.” The market sees only 15% odds of July cut, rising to 75% in September and fully priced in for October.
Chair Powell’s press conference will be key. Powell will likely stick to his familiar script that “we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.” However, we think it is likely that he will drop some hints that the Fed is feeling more confident that it can cut rates sooner rather than later. Of course, this current spike in oil prices could throw a spanner in the works.
Updated Dot Plots and macro forecasts will also be important. We expect the FOMC median Dots to remain unchanged and show two 25 bp cuts in 2025, which is in line with the pricing from Fed funds futures. However, we see some risks of a hawkish shift in the Dot Plots, as it would take only two officials to move from two cuts to one to get a similar move in the 2025 Dot. Paradoxically, 2025 inflation forecasts could be cut modestly, in line with recent favorable readings. Headline PCE is tracking 0.6 ppt below its 2025 projection of 2.7% while core PCE is tracking 0.3 ppt below its 2025 projection of 2.8%. Of note, the unemployment rate is tracking 0.2 ppt below the 2025 projection of 4.4%.
Today’s highlight will be May retail sales. Consensus sees headline at -0.6% m/m vs. 0.1% in April, while ex-autos is seen at 0.2% m/m vs. 0.1% in April. The so-called control group used for GDP calculations, is expected at 0.3% m/m vs. -0.2% in April. Resilient labor market conditions continue to support retail sales activity, at least for now. Weekly jobless claims point to a softer labor market, while the recent order for ICE to suspend raids on agriculture, hotels, and restaurants is another sign of widening cracks. Stay tuned.
Regional Fed surveys for June started rolling out. Empire manufacturing came in at -16.0 vs. -6.0 expected and -9.2 in May. New Yor Fed services will be reported today.
The growth outlook remains relatively strong. The Atlanta Fed GDPNow model estimates Q2 growth at 3.8% SAAR and will be updated today after the data. Elsewhere, the New York Fed Nowcast model estimates Q2 growth at 2.3% SAAR and Q3 growth at 2.5% SAAR and will be updated Friday.
Chile central bank is expected to keep rates steady at 5.0%. It then releases its quarterly inflation report tomorrow. At the last meeting April 29, the central bank kept rates steady at 5.0% and said “Changes in global trade policy have deteriorated the prospects for global growth, while increasing uncertainty about its future evolution. The magnitude and timing of these effects on the local economy are still uncertain.” The swaps market is pricing in 75 bp of easing over the next 12 months that would see the policy rate bottom near 4.25%.
EUROPE/MIDDLE EAST/AFRICA
ECB officials are sounding more confident. GC member Stournaras said “It seems we have reached inflation of 2%, interest rates of 2% so the central bank’s real rate is zero. We are at a first point of equilibrium.” However, he added that “We don’t know whether this equilibrium will be maintained. If the European economy weakens further, if inflation decreases further, below the target - something we don’t want - then we may proceed to further rate cuts but we are data dependent, meeting by meeting. There is so much uncertainty you can’t say in advance if we have finished or not.” The market sees less than 10% odds of a cut at the next meeting July 24. Looking ahead, one more 25 bp cut is priced for this cycle. Villeroy and Centeno also speak today.
June German ZEW investor economic sentiment survey was firm. Expectations rose to 47.5 vs. 35.0 expected and 25.2 in May, while current situation rose to -72.0 vs. -75.0 expected and -82.0 in May. ZEW President Wambach said the latest survey “seems to strengthen the assessment that the fiscal policy measures announced by the new German government can provide a boost to the economy. Combined with the recent interest-rate cuts by the European Central Bank, this could bring economic stagnation in Germany, which has lasted for almost three years, to an end.” Sentiment readings in Germany have been improving steadily, but the drop in the composite PMI to 48.5 in May warns of growing downside risks. June PMI readings for the eurozone will be reported next Monday and will be closely watched.
ASIA
The two-day Bank of Japan meeting ended with the expected hold. Governor Ueda reiterated the bank’s commitment to raising rates if the outlook for economic activity and prices will be realized. Ueda also warned that uncertainty over trade policy is very high. There were no updated macro forecasts at this meeting, as the next BOJ Outlook Report is due at the next meeting July 30-31. The swaps market still sees only 25 bp of tightening over the next 12 months. The BOJ’s cautious normalization cycle is an ongoing headwind for JPY.
The BOJ unveiled a plan to slow the pace of JGB purchases that was broadly in line with expectations. The BOJ will stick to its original July 2024 tapering plan, trimming JGB purchases by JPY400 bln per quarter through March 2026. From April 2026 to March 2027, the BOJ will then reduce the pace of JGB purchases by JPY200 bln per quarter. Only one BOJ member (Naoki) voted to continue reducing JGB purchases by JPY400 billion per quarter but was overruled by an 8-1 majority vote. The BOJ’s next interim bond purchase plan assessment will be at June 2026 policy meeting. The BOJ reiterated that in the case of a rapid rise in long-term interest rates, the Bank will make nimble responses by, for example, increasing the amount of JGB purchases, including additions to the purchase schedule.
