The Bizarro Dollar

May 21, 2025
6 min read
  • The broad USD decline is counter-intuitive amid an increasingly cautious Fed and rising geopolitical tensions.
  • UK inflation overshot expectations in April and argues for more prudent BOE rate cuts. GBP/USD rallied to a multi-year high.
  • Canada faces greater risk of stagflation, complicating the Bank of Canada’s easing cycle.

 

The Bizarro Dollar

US

USD extended recent losses against all major currencies despite widening US interest rate differentials and a report Israel is preparing a strike on Iranian nuclear facilities. Unsurprisingly, safe haven currencies (JPY and CHF) are outperforming, and crude oil prices are up nearly 1.5%. The broad USD decline is counter-intuitive but suggests financial markets are losing confidence in US policies.

USD tends to do well in periods of heightened geopolitical risk aversion as foreign investors seek the safety and liquidity of long-term Treasuries. However, Treasuries declined overnight with the 30-year yield testing highs at 5% and 10-year yield back up above 4.50% on concerns over the escalating US fiscal burden. As written, President Donald Trump's “One Big Beautiful” tax and spending package is estimated to substantially add to the deficit, even if accounting for possible tariff revenue.

Bottom line: 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.

Fed officials are sticking to the no hurry to resume easing script. San Francisco Fed President Mary Daly (non-voter) reiterated that Fed policy is in a good place while Cleveland Fed President Beth Hammack (2026 voter) stressed “Right now I think the best action we can take is to sit on our hands and really carefully go through the data.”

There is no policy-relevant US economic data release today. Richmond Fed President Tom Barkin (non-voter) and Fed Governor Michelle Bowman will participate in a Fed Listens event (5:15pm London).

UK

GBP/USD rallied to its highest level since February 2022 and gilt yields are up over 3bps across the curve. UK inflation overshot expectations in April. Headline CPI increased 3.5% y/y (consensus: 3.3%, BOE projection: 3.4%) vs. 2.6% in March reflecting mainly higher energy and water bills. Core CPI rose 3.8% y/y (consensus: 3.6%) vs. 3.4% in March while services CPI surged to an 8-month high at 5.4% y/y (consensus: 4.8%, BOE projection: 5.0%) vs. 4.7% in March.

The UK disinflationary process is losing momentum and argues for a more cautious Bank of England (BOE) easing path which is GBP supportive. Indeed, BOE Chief Economist Pill said yesterday he was concerned 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.” The one-year swaps curve has trimmed odds for 50bps of cumulative rate cuts.

CANADA

USD/CAD is grinding lower on broad USD weakness and a modest upward adjustment to Canadian interest rate expectations. Canada’s April CPI inflation ran hot. Headline CPI printed at 1.7% y/y (consensus: 1.6%) vs. 2.3% in March driven by lower crude oil prices and the removal of the consumer carbon price. However, core CPI (average of trim and median CPI) was surprisingly strong at 3.15% y/y (consensus: 2.85%) vs. 2.85% in March.

Canada faces greater risk of stagflation. The BOC’s scenario analysis shows Canada’s real GDP growth either stalling in Q2 or contracting over the remainder of 2025. Risk of stagflation will complicate the Bank of Canada’s easing cycle and undermine CAD on the crosses.


 

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