Playing with Fire
US
USD retraced some of yesterday’s sharp losses, US equity futures are modestly lower, and 10-year Treasury yields are down near a multi-day low at 4.41%.
A foreign tax provision in the US House of Representatives’ reconciliation bill – titled the One Big Beautiful Bill Act (OBBBA) is a big red flag. Section 899 of the bill aims to impose additional taxes on foreign investors from countries deemed to have “unfair” tax practices (see here for details). If the bill as presently written takes effect, it would deter foreign investment in US assets at a time when the country faces increasing reliance on foreign capital to finance its ballooning debt. Clearly, this is not good for USD.
The tariffs stay on for now. The US Court of Appeals for the Federal Circuit temporarily blocked “until further notice” the Court of International Trade’s ruling that President Donald Trump's “liberation day” tariff scheme was unlawful. The legal fight continues and may ultimately end up in the Supreme Court. In the meantime, US Treasury Secretary Scott Bessent pointed out overnight that trade talks with China are “a bit stalled.”
Bottom line: trade policy uncertainty will remain high and raises the risk the US enters a period of stagflation which is negative for USD and US stocks.
Trump invited Powell at the White House. According to the Fed’s press release “Chair Powell did not discuss his expectations for monetary policy, except to stress that the path of policy will depend entirely on incoming economic information and what that means for the outlook.” Meanwhile, the White House spokeswoman said “The President did say that he believes the Fed chair is making a mistake by not lowering interest rates.”
Encouragingly, the Fed’s independence remains shielded. Last week, the US Supreme Court allowed the dismissals of certain federal agency officials, but signaled its ruling does not apply to the Federal Reserve Board.
The US April Personal Income and Outlays report is today’s focus (1:30pm London). Headline PCE is expected at 2.2% y/y vs. 2.3% in March and core PCE is projected at 2.5% y/y vs. 2.6% in March. The Cleveland Fed’s inflation Nowcast model estimates headline and core PCE at 2.2% and 2.6%, respectively. The rising ISM prices index point to a reacceleration in inflation pressures (chart below).
Personal spending is expected at 0.2% m/m vs 0.7% in March, and real personal spending is forecast at 0% m/m vs. 0.7% in March. The Atlanta Fed GDPNow model (updated today) currently tracks growth of 2.2% SAAR in Q2 and estimates a 2.49pts contribution from personal consumption spending.
The US economy remains on solid footing, but the impact of the tariffs hasn't fully hit yet. Fed funds futures imply 80% odds that the next 25bps cut will be at the September 17 FOMC meeting and price-in nearly 100bps of cuts by June 2026.
UK
GBP/USD is trading on the defensive near 1.3460. Bank of England (BOE) Monetary Policy Committee (MPC) member Alan Taylor argued for more easing. Taylor warned “I’m seeing more risk piling up on the downside scenario because of global developments” adding he remained “pretty concerned” about the economic outlook.
Taylor’s comments are not surprising as he voted for a 50bps cut earlier this month. Recall, the MPC voted by a majority of 5-4 to reduce Bank Rate to 4.25% at the May 8 meeting. Two members preferred to reduce the Bank Rate by 50bps (Taylor and Dhingra) and two members preferred to keep rates unchanged (Mann and Pill).
In our view, the UK disinflationary process is losing momentum and backs-up the case for a more cautious BOE easing path. This is GBP supportive. The swaps market continues to imply 50bps of easing over the next 12 months and the policy rate to bottom around 3.75%.
JAPAN
USD/JPY is consolidating around 144.00. Tokyo May CPI, a leading indicator for nationwide inflation, ran hot. Headline matched consensus at 3.4% y/y vs. 3.4% in April while measures of core CPI overshot expectations. Both core ex-fresh food and core ex-fresh food & energy rose 0.2pts to 3.6% y/y (consensus: 3.5%) and 3.3% y/y (consensus: 3.2%), respectively. For reference, the BOJ projects core CPI ex. fresh food and core CPI ex. fresh food & energy to average 2.2% and 2.3% in fiscal 2025, respectively.
Swaps market pricing hardly budged and still implies about 50bps of Bank of Japan rate hikes to 1.00% over the next two years. The recent rise in long-term JGB yields is pushing up Japan’s debt services costs. This will limit the BOJ tightening capacity and is a headwind for JPY.
AUSTRALIA
AUD/USD is down near key support at 0.6400. Australia’s April retail sales activity was poor, validating the RBA’s dovish stance. Nominal retail sales unexpectedly fell -0.1% m/m in April (consensus: 0.3%) vs. 0.3% in March driven by declines in clothing, footwear and personal accessory retailing and department stores. RBA cash rate futures adjusted 10bps lower to imply nearly 90bps of easing by June 2026.
CANADA
USD/CAD is holding above key support at 1.3800. Canada March and Q1 GDP reports are the highlights (1:30pm London). Statistics Canada advance information indicates that real GDP increased 0.1% m/m after falling -0.2% in February. For Q1, the Bank of Canada (BOC) estimates real GDP of 1.8% SAAR vs. 2.6% in Q4 reflecting a slowdown in consumer spending, residential investment, and business investment. Further out, the BOC’s scenario analysis shows real GDP either stalling in Q2 or contracting over the remainder of 2025.
The BOC is expected to leave the policy rate unchanged at 2.75% next week. The swaps market is pricing only 30% odds of a 25bps cut while a total of 40bps of easing is implied over the next 12 months. Canada risk entering a period of stagflation which complicates the Bank of Canada’s easing path and is a drag on CAD.
