Yen Leads the Foreign Currencies Lower

May 27, 2025

Win Thin

Another trade truce went into effect; Fed officials continue to set up an extended pause; Conference Board May consumer confidence will be the data highlight; Brazil reports mid-May IPCA inflation
ECB President Lagarde remains bullish on the euro; eurozone May CPI data started rolling out at the country level; Hungary is expected to keep rates steady at 6.5%
Reports suggest Japan’s Ministry of Finance is considering changes to JGB issuance; BOJ Governor Ueda sounded more confident about the trajectory of inflation

The dollar is getting some traction as the U.S. and U.K. return from holiday. DXY is trading higher near 99.383 after two straight down days. The yen is leading this move lower in the foreign currencies after reports emerged that Japan’s Finance Ministry is considering tweaks to its JGB issuance to stabilize yields (see below). USD/JPY is trading higher near 144.15 but remains in the 140-145 trading range. Elsewhere, the euro is trading lower near $1.1345 even as ECB President Lagarde signals she is fine with currency strength (see below), while sterling is trading lower near $1.3535 after making a new cycle high just below $1.36. We continue to view any dollar relief rallies with skepticism. Indeed, today’s recovery based on yen short-covering is unlikely to be sustainable. Easing trade tensions would remove a significant headwind on the dollar over the short-term, but those tensions are likely to pick up over the next couple of weeks as new (and higher) tariffs are announced. Uncertainty remains high as tariffs are sometimes quickly reversed, as we saw with the EU (see below). US policymaking credibility is taking a big hit and that argues for a weaker dollar.

AMERICAS

Another trade truce went into effect. President Trump extended the deadline for EU tariffs to July 9. In return, the EU said it would accelerate negotiations. Senor European Commission official said “There’s now a new impetus for the negotiations. They agreed both to fast track the trade negotiations and to stay in close contact.” The non-partisan Budget Lab policy research center at Yale estimates that 50% tariffs on EU goods would boost the US average effective tariff rate by 4-5 ppt to around 21-22%, reduce 2025 real GDP growth by an additional 0.2 ppt to 0.8%, and increase short-run pressure on PCE inflation by another 0.5 ppt to 2.2%. Bottom line: US protectionist trade policies have raised the risks that the US economy enters a period of stagflation. The numerous reversals also feed into a growing loss of confidence in US policymaker. As such, we expect USD to come under renewed downside pressure.

Fed officials continue to set up an extended pause. Over the weekend, Kashkari said “Anything is possible,” but then asked, will things “be clear enough by September? I am not sure right now. We will have to see what the data says, but also how the negotiations are going.” Kashkari noted that if any trade deals are struck over the next few months, “that should provide a lot of the clarity we are looking for.” Yet the more the Trump administration vacillates on tariffs, the less things will clear up for the Fed. Kashkari, Barkin, and Williams speak today. A June cut has been largely priced out, while the odds of a July cut have fallen to around 25% and less than 70% in September. Looking ahead, the swaps market is still pricing in around 75 bp of total easing over the next 12 month, down from 125 priced in earlier this month.

Conference Board May consumer confidence will be the data highlight. Headline is expected to rise over one point to 87.1 from April, which was the lowest level since May 2020. The sentiment data no longer appears to be a reliable indicator of future spending behavior. Keep an eye on the labor index (jobs plentiful minus jobs hard to get). In April, this measure fell 2.4 points to a seven-month low of 15.1, indicative of weakening labor market conditions. University of Michigan reports its final May consumer sentiment Friday.

The Q2 outlook remains solid. The Atlanta Fed GDPNow model now has Q2 growth at 2.4% SAAR and is right back at its initial estimate. It will be updated today after the data. Elsewhere, the New York Fed Nowcast model now has Q2 at 2.4% SAAR and will be updated Friday. Its initial Q3 estimate should also come Friday. Bottom line: the economy remains on solid footing but the impact of the tariffs hasn't fully hit yet.

Brazil reports mid-May IPCA inflation. Headline is expected to remain steady at 5.49% y/y. If so, inflation would remain a full percentage point above the top of the 1.5-4.5% target range. At the last meeting May 7, the central bank hiked rates 50 bp to 14.75% and noted that the easing cycle in in an “advanced stage” and that calibration of monetary policy depends on how inflation behaves. The bank warned that risks to the inflation outlook in both directions are higher than usual. As such, “This scenario prescribes a significantly contractionary monetary policy for a prolonged period to assure the convergence of inflation to the target.” The swaps market is pricing in one more 25 bp hike over the next three months that would see the policy rate top out near 15.0%.

EUROPE/MIDDLE EAST/AFRICA

ECB President Lagarde remains bullish on the euro. Specifically, she said there is an opportunity for a “global euro moment.” Lagarde highlighted that the changing landscape - where multilateral cooperation is being replaced by zero-sum thinking and bilateral power plays – could open the door for the euro to play a greater international role. For this to happen, Lagarde recommends that the EU forge new trade agreements, build robust military partnerships, complete the Single Market, and uphold a robust legal and institutional foundation. We believe there is room for the euro to have a larger weight in the share of foreign exchange reserves held by central banks (currently around 19.8% vs. 57.8% for USD). First, common EU debt issuance is expected to reach nearly EUR1 trln by 2026. This will add a substantial amount to the current supply of low-risk assets in the euro area, enhancing the euro’s appeal as a reserve currency. Second, the ECB is well on its way to issuing a digital euro to simplify cross-border transactions in the single currency. This could chip away at the dollar’s dominance as a medium of exchange.

Eurozone May CPI data started rolling out at the country level. France’s EU Harmonised inflation came in three ticks lower than expected at 0.6% y/y vs. 0.9% in April. This was the lowest since December 2020. Spain, Italy, and Germany all report Friday. Spain’s EU Harmonised inflation is expected to fall two ticks to 2.0% y/y, Italy’s is expected to fall a tick to 1.9% y/y, and Germany’s is expected to fall two ticks to 2.0% y/y. Spain is one of the only eurozone countries to report core CPI and it is expected to fall two ticks to 2.2% y/y. Eurozone-wide CPI data won’t be reported until next Tuesday.

National Bank of Hungary is expected to keep rates steady at 6.5%. At the last meeting April 29, the bank kept rates steady at 6.5% and said “Restrictive monetary policy contributes to the maintenance of financial market stability, the anchoring of inflation expectations consistently with the central bank target and, as a result, to the achievement of the inflation target in a sustainable manner by ensuring positive real interest rates.” Governor Varga added that rates would be kept at the current level for a “sustained period.” Despite this hawkish stance, the swaps market is pricing in 75 bp of easing over the next 12 months.

ASIA

Reports suggest Japan’s Ministry of Finance is considering changes to JGB issuance. Reports emerged that the Finance Ministry sent a questionnaire to market participants asking for their views on JGB issuance and current market conditions. Elsewhere, Reuters reported the Finance Ministry might consider tweaking the composition of its bond program by reducing super-long bond issuance and selling more shorter-dated debt, though total issuance would remain unchanged. USD/JPY rallied nearly 1% and super long-term (20-, 30-, and 40-year) JGB yields plunged around 20 bp. It’s clear that policymakers are concerned about the recent spike in yields. However, a shift in issuance towards the short end is unlikely to address overall concerns about Japan’s fiscal sustainability. Stay tuned.

Meanwhile, Bank of Japan Governor Ueda sounded more confident about the trajectory of inflation. Ueda noted “given that underlying inflation is closer to 2% than a few years ago, we need to be careful about how food price inflation will impact underlying inflation,” adding that Japan is now closer to its inflation target than at any other time in the last three years. No change is expected at the next policy meeting June 16-17. The swaps market is pricing in nearly 50 bp of tightening over the next two years.

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