Dollar downtrend resumes as markets price in Fed cuts

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The dollar broke to fresh post-Liberation Day lows as pressure builds on the Federal Reserve to cut rates.

his pressure comes from both the Trump administration, which is making increasingly clear that it does not believe in central bank independence, and a weaker tone in economic data out of the US. On the positive side, we are not seeing a continuation of the worrisome “sell America” trade that spooked markets in April. US stocks are actually hitting fresh record highs and the Treasury market is also holding up quite well. Nevertheless, the greenback is again acting as an escape valve for trade conflicts and last week fell sharply against almost every major currency in the world.

Two economic reports will be the centre of attention next week. On Tuesday, the flash inflation report out of the Eurozone will help clarify how much room is there for the ECB to cut rates further. In the US, a slate of labour reports starting on Tuesday with JOLTs will culminate in the all-important June payrolls report on Thursday. Much of the recent dollar weakness is a reaction to perceived weakness in US data. The jobs report will provide definite confirmation or rejection of the thesis of a meaningful US slowdown. We expect to see meaningful currency moves in response.

GBP

The PMI indices of business activity for June came out slightly above expectations, which helped dispel some of the gloom from recent poor employment and retail sales data out of the UK. Consequently, sterling managed to keep up with other European currencies amid the generalised dollar sell-off, a sharp contrast to recent underperformance.

This week, there is not a lot on tap in terms of timely economic reports, so the pound will trade mostly off events elsewhere while we await clarity on the path of cuts by the Bank of England.

EUR

The May PMIs in the Eurozone did not really change the picture of a barely growing economy that is relying for now on the prospect of massive fiscal stimulus from Germany later in the year. That is not getting in the way of the euro rally against the dollar, however, as hedging flows from investors overexposed to US assets combine with shrinking rate differentials between the US and Europe.

Tuesday’s inflation report will help clarify whether there is really any further room for the ECB to cut rates from 2%, which is the same level inflation is expected to print in June.

USD

Economic data released last week showed a mixed performance. Weak housing starts and personal income and spending were offset by lower jobless claims and strong durable goods orders. Overall, the tone of the last few weeks has been soft but nowhere near enough so to be conclusive.

This week’s labour data should go a long way towards settling this key question. We will also be paying close attention to the fate of the budget bill in the US. Negotiations are heated, and its failure would imply a significant fiscal tightening starting next year. We regard this as a low-probability scenario, however.