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Mounting fiscal concerns triggers fresh US dollar retreat

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27 May 2025

Written by
Matthew Ryan

Matthew Ryan is Ebury’s Global Head of Market Strategy, based in London, where he has been part of the strategy team since 2014. He provides fundamental FX analysis for a wide range of G10 and emerging market currencies.

Markets are increasingly concerned with the prospect of endless fiscal deficits and rising government debt, particularly in the US. 

T
he lower chamber of US Congress last week approved a budget bill that implies yet another gusher of red ink, and investors reacted by selling US Treasuries and the dollar. The latter rose in response to higher US rates, but the polarity of that correlation has reversed since “Liberation Day”. Long bonds sold off worldwide, although US moves were generally sharper. The dollar fell against every major currency worldwide, albeit the greenback remains some way off its post 2nd April lows. The star of the week was the Japanese yen, which appears to be benefiting the most from the ongoing global repricing in interest rates.

There is a spate of economic reports on tap this week out of the US: orders for durable goods, personal income, spending, PCE inflation, and the newly relevant weekly jobless claims. Investors will be looking at all of these closely to assess any fallout from Trump’s tariffs. Headlines from Trump’s social media feed will also be important. Yet, markets are becoming somewhat numb to these, as was the case with the announcement and postponement of the 50% tariff on the European Union. Weekly auctions of US Treasury bonds will garner increased attention, after a weak 20-year bond sale turned out to be a catalyst for the long bond sell off.

GBP

The massive inflation shock last week means that the Bank of England’s recent hawkishness is fully validated and the pound looks set to remain the second highest-rate G10 currency after the dollar for the foreseeable future. Together with the UK economy’s relative immunity from Trump’s tariffs, the prospect for closer ties with the European Union and resilient domestic demand, we are comfortable justifying the pound’s continued rally.

This week offers no major data points, although we are set to hear from a handful of MPC members in the coming days, including Governor Bailey, and it will be intriguing to hear their view on last week’s nasty inflation shock and bumper retail sales figures. We suspect that the “gradual and careful” stance towards easing will be reiterated once more, and most committee members are likely to pour cold water over the possibility of another cut any time soon (markets are not fully pricing in the next rate reduction until November).

EUR

The European Union appears to be the latest target of Trump’s tariff threats, but markets have been conditioned to expect lots of noise and little follow through from the US president. The common currency largely ignored both the threat and the backdown, and seems to have found a firm, albeit gradual upward trend.

The fiscal picture in the Eurozone is nowhere as dire as in the US, with average deficits stable at levels of less than half of those across the Atlantic, in spite of the German fiscal plan. This relative sanity may be helping to support the common currency as investors pay increased attention to fiscal sustainability. On the negative side, good news on inflation has probably cleared the way for at least two further ECB rate cuts by the end of the year.

USD

The sell off in Treasury markets amid fears surrounding the President’s “Big, Beautiful Bill” is keeping the dollar down, in yet another reversal of currency correlations that had held for decades. On the positive side for the greenback, economic data shows little tariff-related damage, and now even business activity surveys, including last week’s composite PMI from S&P, are normalising. We’re also not seeing any signs of a deterioration in the labour market, with recent jobless claims figures not pointing to mass layoffs in the US economy.

Paradoxically, sharply rising tariff revenue is providing the only positive fiscal news. The latter, together with sharply higher US Treasury yields and a very one-sided market where positioning data shows that speculators are significantly short the dollar, may provide some short term relief for the currency, but the longer trend is probably down.

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