Waiting for Impact

US

USD extended its technical relief rally against most major currencies. The US economy remains on solid footing. The Conference Board consumer confidence index soared more than expected in May to a three-month high at 98.0 (consensus: 87.1) vs. 85.7 in April. Regardless, the sentiment data no longer appears to be a reliable indicator of future spending behavior. Meanwhile, the Atlanta Fed GDPNow model estimates Q2 growth at a decent 2.2% SAAR vs. 2.4% on May 16 but the impact of the tariffs hasn't fully hit yet.

In our view, US protectionist trade policies have raised the risk the US economy enters a period of stagflation. Moreover, US policymaking credibility is taking a big hit as reflected by the recent divergence in the dollar and interest rate differentials. As such, we expect USD to come under renewed downside pressure once oversold technical conditions unwind.

The FOMC May 7 meeting minutes is published later today (7:00pm London). At that meeting, the FOMC voted unanimously to leave the target range for the funds rate unchanged at 4.25-4.50%. The statement stressed that “Uncertainty about the economic outlook has increased further” and “the risks of higher unemployment and higher inflation have risen.” Meanwhile, Fed Chair Jay Powell reiterated that “we are well positioned to wait for greater clarity before considering any adjustments to our policy stance.”

Since then, most Fed officials have stuck to the wait-and-see policy script. Fed funds futures imply about 70% odds that the next 25bps cut will be delivered at the September 17 meeting.

EUROZONE

EUR/USD is down near 1.1300 on USD strength. ECB Chief Economist Philip Lane said the ECB is unlikely to lower its policy rate (currently at 2.25%) below 1.50%. According to Lane “Rates below 1.5 per cent are clearly accommodative…Going there would only be appropriate in the event of more substantial downside risks to inflation, or a more significant slowdown in the economy. I do not see that at the moment.” The swaps market agree and price in the policy rate to bottom at 1.60% over the next 12 months.

The ECB has room to deliver more easing as longer-term inflation expectations remain anchored around 2%. The ECB April consumer inflation expectations survey is up next (9:00am London). 1-year expectations are forecast at 2.8% vs. 2.9% in March, 3-year expectations are projected at 2.5% vs. 2.5% in March and 5-year expectations will likely remain unchanged at 2.1% for the fifth consecutive month.

JAPAN

Long-term JGB yields retraced some of yesterday’s decline reflecting weak demand at a 40-year bond auction. The sale's average bid-to-cover ratio was 2.21, the weakest since July. As a result, 40-year JGB underperformed across the curve. The recent rise in long-term JGB yields is pushing up Japan’s debt services costs, limiting the Bank of Japan’s tightening capacity which is a headwind for JPY.

USD/JPY is trading in a tight range around 144.50. In the short term, the build-up of heavy stale long JPY positions increases the risk of a sharper move lower in JPY as positioning clears. USD/JPY is vulnerable to a rebound towards its 200-day moving average at 149.60.

NEW ZEALAND

As was widely expected, the RBNZ cut the Official Cash Rate (OCR) by 25bps to 3.25%. The RBNZ’s updated OCR path was tweaked lower towards swaps market pricing to imply nearly 50bps of additional easing. The RBNZ now projects the OCR to bottom at 2.85% in Q1 2026 vs. 3.10% previously.

However, the RBNZ signaled that the bar for more cuts is high which underpinned NZD and New Zealand yields. First, the RBNZ noted that “inflation is within the target band.” Second, the RBNZ scrapped previous guidance that it “has scope to lower the OCR further as appropriate.” Third, the RBNZ discussed the option of keeping the OCR on hold at 3.50% and voted 5-to-1 in favor of a 25bps cut. Fourth, RBNZ Chief Economist Paul Conway pointed out that the OCR is now close to its neutral level, which the RBNZ estimates to be between 2 and 4%.

AUSTRALIA

AUD/USD is edging lower towards its next key support at 0.6400. Australia’s April CPI inflation ran a little hot. Headline CPI printed at 2.4% y/y (consensus: 2.3%) vs. 2.4% in March and the trimmed mean CPI rose 0.1pts to 2.8% y/y. It’s worth noting, that the RBA focuses on the quarterly CPI data because it’s less volatile and captures more items than the monthly CPI indicator.

At its last May 20 meeting, the RBA cut the cash rate target 25bps to 3.85% and stressed that “Inflation is in the target band [2-3%] and upside risks appear to have diminished.” Indeed, the RBA projects the policy relevant trimmed mean inflation at 2.6% (down from 2.7% previously) across its forecast horizon to 2027. RBA cash rate futures continue to price-in a total of 75bps of cuts to a low of 3.10% in the next 12 months.