Dollar gains in spite of Trump’s tariff barrage
Financial markets seem to be weathering the latest round of Trumpian chaos.
Highlights:
US dollar gains as “sell America” trade fades.
Trump threatens more tariffs as 01/08 deadline looms.
UK economy contracts again in May. BoE August cut eyed.
Yen hammered as Trump pledges 25% Japan tariffs.
AUD jumps after surprise hold from the RBA.
CAD buoyed by stellar Canadian jobs report.
The letters he keeps sending to trading partners announcing very high tariffs starting in August are being interpreted as yet another postponement of his 9th July deadline, and are mostly seen as negotiating bluster. G10 currencies are holding within tight ranges of each other, and it is notable that the market’s reaction is to either ignore the tariff news, or even boost the dollar – a marked departure from the initial response to “Liberation Day” back in April. Only the US Treasury market continues to send ominous signals, as long term bonds sell off in reaction to the US budget bill and the prospect of massive deficits as far as the eye can see, but even this is so far orderly.
This resilience is certain to be tested this week. Markets will closely follow the trade negotiations for any hints of progress. An additional source of worry for the dollar will be Trump’s assault on the Fed’s independence as he pressures the central bank to lower rates faster than it is inclined to. A strong US inflation print for June on Tuesday could strengthen the Fed’s hand. The UK macroeconomic calendar is also unusually busy. June inflation data on Wednesday will be followed by the critical labour market data for May and June the following day.
USD
As mentioned, the dollar actually rallied amid the prospect of higher tariffs last week. This is a break from the post-Liberation Day norm, but a return to the conventional way of thinking, whereby greater trade protectionism and heightened global uncertainty is generally seen as bullish for the greenback. Meanwhile, markets so far seem to be siding with Fed Chair Powell in his conflict with the White House, and have almost ruled out any chance of a cut in rates at July’s FOMC meeting, particularly following the June nonfarm payrolls report.
We look to the June inflation report on Tuesday to validate the Fed’s stance. Feed through from the tariffs to inflation has been very limited so far, but we doubt that this can last forever. Importers will eventually run out of the inventory they accumulated earlier in the year before the tariffs hit, and prices should adjust upwards, especially given the background of healthy growth in consumer spending. Meantime, the dollar seems to need some catalyst before it breaks down to lower lows, and a healthy inflation print is unlikely to provide it.
EUR
President Trump’s threat of a 30% tariff on the European Union over the weekend, effective 1st August, has so far been taken in stride by market participants. We see this as another move straight out of the Trump negotiating playbook, rather than a concrete pledge, particularly as most of the latest communications from both sides of the negotiations have indicated that the striking of a framework trade deal is not too far away.
As was the case throughout much of last week, this week presents little market moving economic data out of the Euro Area, though there will be a series of speeches by European Central Bank officials. Now that ECB rates are at 2%, markets see room for at most one additional cut, and that is not expected any time soon. European monetary policy has now settled into a holding pattern, and the main driver for the euro for now should, therefore, be events elsewhere . Namely, the performance of the US economy and news of the Trump conflict with Fed chair Powell.
GBP
The sharp drop in payrolled employees in Britain in May has cast a gloomy pall on sterling and UK assets generally, as it suggests that employers are reacting badly to the latest round of tax increases. This means that Thursday’s publication of the May/June employment data is critical, perhaps even more so than Wednesday’s inflation report, which is expected to show little change from the previous month.
By Thursday afternoon this week we, and the Bank of England for that matter, should have a clearer view of the extent of weakness in UK economic data. Last week’s dismal monthly GDP print for May was not at all an optimistic sign, as this almost guarantees that Britain’s economy contracted on a quarterly basis in the second quarter. Not only does this make an August rate cut from the Bank of England increasingly likely (almost 90% priced in by swap markets), but it also raises the risk of additional tax hikes in the autumn, which now seem practically inevitable. This is not a particularly appetising prospect for the pound, which has continued to underperform most of its G10 peers in the past week.