The market was caught leaning the wrong way. Anticipation that Federal Reserve Governor Powell was going to push against speculation of a September rate cut had underpinned the US dollar and short-term rates. The S&P 500 had sold off for five consecutive sessions, the longest losing streak of the year through August 21. Powell said two things that spurred a rally in US financial assets and triggered a sharp and broad dollar sell-off. The Fed Chair said that the "situation suggests downside risks to employment are rising" and that the "shifting balance of risks may warrant adjusting policy." Moreover, we note that the early forecasts point to another poor employment report, due September 5. The median forecast in Bloomberg's survey is for nonfarm payrolls to rise by 83k (73k in July) and for the unemployment rise to 4.3% from 4.2%.
As August winds down, and ahead of a long US (and Canadian) holiday weekend, the high frequency economic data does not appear to have the gravitas to substantially impact policy views. The price action itself is the story. The price action ahead of the week confirms the dollar's sensitivity to changes in interest rates, contrary to the conventional wisdom (e.g., here). The US needs to offer investors higher interest rates to support the dollar and policy rates are headed in the opposite direction. The policy divergence between the Fed and most other G10 central banks (leaving aside the BOJ) is likely to widen in a direction that will likely continue to weigh on the dollar. Nor does President Trump's threat to fire Fed Governor Cook if she does not resign does not set well with the market that sees it as another attempt to encroach on the independence of the central bank. In this context, Governor Waller's offer of strong defense of the Fed's independence may diminish his chances of becoming chair, while the likelihood of Powell remaining on the board as governor after his term as chair ends (May 2026) appears to have increased.
US
Drivers: The key to the dollar's rally in July and its heavier tone this month is the shift in US interest rates and Fed expectations. Consider that the 10-year Treasury yield rose nearly 15 bp in July and gave is off a dozen basis points this month. The two-year yield rose almost 24 bp in July and is off around 25 bp here in August. The implied year-end effective Fed funds rate (weighted average) rose 33 bp in July and is also about 22 bp lower this month. Fed Chair Powell acknowledged that the "shifting balance of risks may warrant adjusting policy" and warned that "downside risks to employment" may be rising.
Data: There are economic reports nearly every day this week, but they do not appear to have the heft to significantly change the market's conviction that the Federal Reserve will resume unwinding the restrictiveness of the current monetary setting. Fed officials have eschewed survey data. The decline of Boeing orders (303 in May, 116 in June, and 31 in July) set the stage for the second consecutive decline in durable orders and the third in four months. Excluding aircraft and defense orders, core capital goods orders fell by an average of 0.1% in Q2, the first negative quarter in a year. Personal income and consumption remain firm and may have advanced sequentially, though when adjusted for inflation, personal consumption expenditures were flat in H1 after rising 2.4% in H2 24 and 1.2% in H1 24. The data in the CPI and PPI allow economists to have a good handle on the PCE deflator, which the Fed targets. A 0.3% rise in both the headline and core deflators will, depending on the rounding, lift the year rates to 2.7%-2.8% and 2.9%-3.0%, respectively. The question is not whether the tariffs will boost prices but whether the price pressure will be sustained.
Prices: In broad terms, after falling for the first six months of the year, the dollar recovered in July. It gave some portion back in the first part of August and traded firmer last week, helped by the backing up of US interest rates, until Powell's speech at Jackson Hole. The high for the week was recorded before the weekend near 98.85 before reversing sharply and settled below the previous day's range (~98.20) for a bearish outside down day. The break of the 97.80 area may be an early warning of the risk of a return to the July 1 low that was slightly below 96.40.
EMU
Drivers: The euro is supported by the fact at it is a liquid and deep alternative to the US dollar. The two-year interest rate discount for holding euros has diminished. The market has turned more dovish the Fed and continues to pare its dovish ECB wagers. The year-end deposit rate, projected by the overnight swaps market is above near 1.85%, the highest since the end of Q1.
Data: Eurozone data is largely limited to the M3 and the associated lending figures, for which the market is not particularly sensitive to, and the ECB's survey of inflation expectations. The one-year expectation was at 2.6% in June and the three-year expectation was at 2.4%. They were at 2.8% and 2.4% respectively in July 2024. The eurozone's July CPI was 2.0% higher year-over-year.
Prices: After correcting lower in July (to slightly below $1.14), the euro recovered in the first half of August and reached $1.1730 on August 13. On the back of higher US rates, the dollar recovered broadly and sent the euro through the (38.2%) retracement of the gains in the first part of the month found near $1.1600. The low for the week, recorded before the weekend, was slightly below $1.1585, but Powell's apparent endorsement of a September rate cut sent the euro to a new high for the month (a little above $1.1740). It settled above the previous session high (~$1.1665), forging a bullish outside up day. The trendline connecting the July highs comes in near $1.1740 on Monday. The $1.1800-30 is the next important technical area. Our call for $1.20 before the end of the year may still prove to be conservative.
PRC
Drivers: Officials are determined to keep the yuan broadly stable against the US dollar. It is accepting minor appreciation. Many foreign observers focus on the large trade surplus and argue for a re-valuation of the yuan. As we have noted, the relationship between trade and foreign exchange levels is not simple. Japan, we have noted, records a trade deficit, while by most metrics, the yen is undervalued. Switzerland, which according to the OECD's model of purchasing power parity, is the only G10 currency that is overvalued relative to the dollar, reported trade surplus in H1 25 that was more than a third larger than H1 24, which itself was about 19% greater than the surplus in H1 23. On the other hand, with deflationary forces still gripping the economy, currency appreciation and the implication of tighter financial conditions is not the traditional economic prescription.
Data: The yuan, closely managed, does not appear to be sensitive to high frequency data. Still, the only data point of note is the July industrial profits. In June, industrial profits fell 4.3% year-over-year, offsetting the 4.1% gain reported in 2024. In June 2023, industrial profits 8.3% lower year-over-year. This seems to stem from China's over-investment and the competition for market share rather than profits. Beijing recognizes this and has launched a campaign to check it.
Prices: Even as the PBOC has gradually lowered the dollar's reference rate, the greenback has not continued to fall. It bottomed a month ago, slightly below CNY7.15. The greenback fell to a new low for the month before the weekend slightly near CNY7.1635. The US dollar posted its lowest close against the offshore yuan in nearly a month before the weekend (~CNH7.1715).
Japan
Drivers: The yen's exchange rate remains highly sensitive to changes in US interest rates. Consider that over the past 30-day, the correlation of the changes in the exchange rate and the US two-year yield is ~0.80, while the correlation with the two-year JGB is near zero and has fluctuated with year between -0.40 in March to a little more than 0.35 in early June. The correlation between changes in the two-year yield differential and the exchange rate is slightly below the correlation with the US two-year. The correlation with the 10-year yield tells a similar story. The rolling 30-day day correlation of changes in the exchange rate and the 10-year Treasury yield is near 0.75, while the correlation with the 10-year JGB is slightly inverted.
Data: The Q2 GDP was stronger than expected at 1.0% at an annualized rate and Q1 GDP was revised to 0.6% from -0.2%. The July industrial production, employment, and retail sales figures are due at the end of the coming week. It will show the kind of momentum at the start of Q3. While retail sales look firm, industrial output may have contracted. However, more important for the Bank of Japan may be the signal from the Tokyo CPI, which offers important insight into the national figure that will be reported in several weeks. All the key measures are expected to have softened. Ahead of the data, the swaps market has almost 20 bp of tightening discounted for this year. The risk of a move next month is seen as minor, which leaves two meetings. The swaps market is pricing about a 50% chance of a quarter-point hike in October and nearly 80% chance of a hike before the end of the year.
Prices: The dollar rose to almost JPY148.80 area at the end of last week. It was the highest level since August 1 and was above the (50%) retracement of this month's losses (~JPY148.55). Yet, Powell's apparent endorsement of September rate cut saw US rates and the dollar tumble. The dollar reversed lower and fell slightly below JPY146.60, which was a new low for the week. The poor settlement was the lowest since July 23. The lower end of the range is around JPY146, and the greenback has not traded below it since July 4. The trendline connecting the April and July lows comes in near JPY144.85 on Monday and almost JPY145.10 at the end of the week.
UK
Drivers: The broad direction of the dollar, reflected in the Dollar Index, is a key factor in sterling's exchange rate. The 30-day correlation of the changes in the two is nearly 0.80. The correlation with changes in the euro is a little less (~0.76). Here too, we see the exchange rate more sensitive (higher correlation) with US rates than UK rates. To wit: the 30-day correlation of changes in the exchange rate and the two-year US yield is almost -0.50, while the correlation with the two-year Gilt is barely positive. The correlation with the two-year rate differential (UK-US) is almost -0.25.
Data: It is a light week for UK macro data. The BRC August shop price index and the CBI retail reports typically do not inspire trading.
Prices: Sterling overshot the (61.8%) retracement of last month's slide, reaching almost $1.3600 on August 14. It subsequently traded lower and reached almost $1.3390 ahead of the weekend before Powell's comments saw it scream higher. Sterling rose to almost $1.3545 to approach the week's high set on Monday slightly above $1.3565. Sterling looks poised to re-test $1.3600. A move above there will set sights on the July 1 high near $1.3790 but there may be potential toward $1.40 in the coming months.
Canada
Drivers: The Canadian dollar remains sensitive to the US dollar's broad direction. The 30-day correlation of changes in the US dollar against the Canadian dollar and the Dollar Index is a little above 0.75. This has not been above 0.80 in more than a year. In early February, the correlation was near an 18-month low around 0.20. The exchange rate's sensitivity to changes in the US S&P 500, we have used as a metric for risk appetites, has slackened. The 30-day correlation was near -0.50 at the start of the year and was almost +0.45 in early June and is slightly positive now. The 100-day rolling correlation is -0.15, which is the least inverse correlation since early 2018.
Data: The monthly GDP shows the Canadian economy contracted by 0.1% in April and May, after growing by a monthly average of 0.13% in Q1. The median forecast in Bloomberg's survey anticipates 0.1% expansion in June, while projecting a 0.3%-0.5% annualized contraction in Q2 (two different surveys) after 2.2% growth in Q1 25. The economy is seen doing slightly better than stagnating in Q3.
Prices: The Canadian dollar does not fit the general pattern we have seen in the other currencies. It weakened to three-month lows, and even the stronger than expected retail sales (ex-autos, up 1.9%, after three consecutive monthly declines) were unable to stem the rot. The US dollar's low for the year was set in mid-June near CAD1.3540. Higher lows were set in early and late July. The greenback took out the August 1 high (~CAD1.3880) last week and rose through CAD1.3900, reaching CAD1.3925 before the weekend. The Canadian dollar showed little reaction to the stronger than expected retail sales (1.9% excluding autos, well above expectations and more than offset the outright decline of the previous three months). But then Powell spoke, and the greenback was sold to a three-day low near CAD1.3810. As often is the case in a weak US dollar environment, the Canadian dollar under-performed. Its 0.70% gain against the dollar was the least among the G10 currencies.
Australia
Drivers: The correlation between changes in the Australian dollar and Dollar Index over the past 30 sessions is a little more than -0.80, the most extreme in a year. The 100-day correlation is near -0.60, which is around the middle this year's range. Over the past 30 sessions, the correlation with the changes in the Canadian dollar is about -0.80, near the most extreme since March.
Data: There are two highlights this week. The first is the record from this month's central bank meeting that resulted in a quarter-point rate cut. The impact may be most acute on the expectations for next month's meeting. The futures market has about a 1-in-3 chance of a cut on September 30, but another cut fully discounted by the end the year. The market sees the cash target slightly below 3.0% (from 3.6% currently), which currently projected to be the terminal rate.
Prices: The Australian dollar, like Canadian dollar, was sold fell to a new low for the month last week near $0.6415. It recovered smartly in response to Powell's comments and briefly poked above $0.6500. In one fell swoop, it retraced more than half of its losses since this month's high set August 14 (~$0.6570) and approached the (61.8%) retracement near $0.6510. The (50%) retracement of the decline since the year's high was recorded (July 24 ~$0.6625) is near $0.6520, with the (61.8%) retracement close to $0.6545.
Mexico
Drivers: The broad decline in the dollar has lifted emerging market currencies. The JP Morgan Emerging Market Currency Index is up about 6.75% so far this year, while the MSCI version has risen by around 6.0% this year. The Mexican peso has appreciated by around 11.3%. This puts it in seventh place among the best performing emerging market currencies this year. Central European currencies, including the Russian ruble account for five of the best and the Brazilian real nearly 13% gain this year puts in the top four.
Data: Mexico reports July's trade balance. In the first six months of the year, Mexico recorded a $1.4 bln surplus. In H1 24, Mexico had a trade deficit of $10.9 bln and a $6.98 bln deficit in H1 23. The last time that Mexico had a surplus in the first six months of the year was in 2021 (~$1.37 bln). Exports have risen by almost 4.4% and imports have risen by nearly 1.8%. July unemployment is also due. It averaged 2.66% in Q2, the highest quarterly average since Q3 24. It stood at almost 2.70% in June, up from 2.43% at the end of 2024 but down slightly from last June's 2.78% unemployment rate. The central bank's inflation report is also due. New economic forecasts will be presented. The current target rate is 7.75% and the swaps market has two more quarter point cuts discounted. The risk is on the downside, assuming the US growth slows, and the Fed's rate cuts resume.
Prices: The dollar had been coiling in a narrow range set on Monday (~MXN18.7120-MXN18.8675) and broke down before the weekend to nearly MXN18.57. The MXN18.50 area must go to be anything of technical significance. The broad sideways movement puts the momentum traders and trend followers as a disadvantage. The carry for dollar-based investors is important. Consider that so far here in Q3 the peso has risen by about 0.85%, the third best among emerging market currencies, but with the carry (interest rate pick up), the peso has returned a little more than 2% to dollar-based investors. Among emerging market currencies, Latam currencies count for three of four of the top six total returns among here in Q3 (Colombian peso ~3.55%, Turkish lira ~3.0%, South African rand ~2.60%, Brazilian real ~2.3%, Mexican peso ~2.05%, and the Peruvian sol ~1.60%).
Reviewed by Marc Chandler
on
August 23, 2025
Rating:
