The US economy appears to be re-accelerating here in Q2 after nearly grinding to a halt in Q1 (0.5% annualized pace). April US CPI and PPI were more elevated than expected. The anticipated average effective Fed funds rate in December rose more than 15 bp in the past week and is up slightly more than 75 bp since the war on Iran began. The Dollar Index rose almost 1.4% last week, its best week since the first week of March.
In addition to the swinging pendulum of market expectations for the Federal Reserve, which has a new chair (and will likely usher in a new era for the central bank), UK political drama that appears likely to bring down Prime Minister Starmer, added to the pressure on sterling and UK stocks and bonds. The market has taken the yen to its lowest level since the end of April's apparent intervention. It will begin the week ahead testing the resolve of Japanese officials. Lastly, Trump-Xi meeting was heralded as a success by both sides. Despite Beijing promises to buy more beans, beef, planes, and energy) from the US, Washington is a dilemma. If it proceeds with the $14 bln arms package to Taiwan, it will risk the wrath of Beijing, but it is shelved, the administration's domestic critics will cry "appeasement".
US
Drivers: There are two main drivers of the Dollar Index now: Changes in US rates and risk-environment. The rolling 60-day correlation of changes in the Dollar Index and two-year yields is near a six-month high a little over 0.50. The correlation with changes in the 10-year yield is slightly higher. Changes in the two and 10-year yields are around 0.90 correlated over the past 60 days, which is the most in three years. Changes in the Dollar Index and the VIX are correlated over the past 60 days by the most since June 2024 (~0.4)9. The Dollar Index is inversely correlated with the S&P 500 itself, and the inversion over the past 60 sessions is the most since January 2023 (~-0.57).
Data: After the recent jobs and inflation data, this week's high-frequency reports are of a secondary importance. Economists pour over the March TIC report and the minutes from the recent FOMC meeting, but the impact on the capital markets may be minimal. May survey data (including the preliminary PMI, the Philadelphia Fed's monthly survey) may pose headline risk. The Atlanta Fed's GDPNow sees the economy tracking 3.7% growth here in Q2 after Q1's 2.0% annual pace.
Prices: With last week's advance, the Dollar Index has recouped a little more than half of what is lost in the pullback from the year's high set on March 31 (~100.65). The next retracement target is in the 99.50 area, which is also the top of an old gap (from the lower opening on April 8). The momentum indicators are constructive, and the five-day moving average crossed back above the 20-day moving average. A move toward 100.00 looks reasonable.
EMU
Drivers: The euro is more sensitive to changes in the short-term US rates than it is to short-term German rates. The 60-day correlation between changes in the euro and the US two-year yield is inverse by nearly -0.50, the most extreme since last November. Intuitively, this makes sense. Higher US interest rates make the dollar more attractive. Yet the 60-day correlation between changes in the euro and changes in Germany's two-year yield is also inverse (~-0.30). Theory says the differential should be more important but the rolling 60-day correlation with the exchange rate is much weaker and statistically insignificant (~-0.10).
Data: With Q1 GDP in hand (0.1%), the eurozone's March trade and current account surplus are largely old news, as is the final April CPI and March construction spending. The preliminary May PMI is due on Thursday. The market remains confident that the ECB will hike rates when it meets on June 11. The swaps market has nearly 80% probability discounted and is pricing in two hikes fully and a little more than a 60% chance of a third.
Prices: For the third time this year, the euro declined for five consecutive sessions. The drop has seen int retrace about half of what it gains since the mid-March low near $1.1410. With the momentum indicators falling and the five-day moving average crossing below the 20-day moving average, there appears to be scope for additional near-term losses. Initial support is seen in the $1.1580-$1.1600 area and a break could signal a move toward the April lows near $1.1500. It may take a push back above the $1.1685 area to stabilize the technical tone.
PRC
Drivers: The PBOC has continued to use the fix to signal its tolerance for a stronger yuan and weaker dollar. While some observers linked to it last week's Trump-Xi meeting, we see it has having begun around the middle of last year. Moreover, the rolling 60-day correlation between changes in the Dollar Index and the offshore yuan is near 0.80, the highest in nearly a decade.
Data: China reports April macro data early Monday. Both retail sales and industrial output are expected to rise sequentially on a year-over-year basis. Several large Chinese cities have taken measures to support the housing market but new and used house prices likely continued to decline, and property investment looks weak. Beijing appears to be relying more on fiscal policy to support the economy than new monetary measures, and the market has backtracked from earlier speculation of a rate cut. Without new signals from officials, the prime loan rates will remain steady when set on May 20.
Prices: The dollar's broad recovery points to a consolidation of the yuan after it rose to new three-year highs. The greenback was sold to about CNH6.7815 on May 14. Ahead of the weekend, the dollar settled above the five-day moving average for the first time this month. It reached CNH6.8140. A band of resistance may extend from CNH6.8150-CNH6.8250. The CNH6.85 area may offer a more formidable cap.
Japan
Drivers: The threat of intervention tempers the bearishness toward the yen. Still, the yen seems to be driven by two main considerations. The first is the dollar's general direction. The rolling 60-day correlation between changes in the dollar-yen exchange rate and the Dollar Index is near 0.75, the upper end of this year's range. The second is the 10-year US yield. Changes in the dollar-yen exchange rate and the 10-year Treasury yield are hovering near 0.60, the highest since last October. The rolling 60-day correlation between the exchange rate and Japan's 10-year yield has a positive sign, and while the less than 0.10 correlation is statistically insignificant, it is near highest in four months.
Data: Japan reports Q1 GDP on Tuesday. The median forecast in Blomberg's survey calls for a 0.4% quarter-over-quarter growth (0.3% in Q4 25) and 1.4% at an annualized rate (1.3% in Q4 25). The GDP price deflator is seen slightly softer at 3.2% from 3.4% in the previous quarter. The April trade figures are also due, and there is a strong seasonal pattern (16 of 20 years) that balance deteriorates in April. Despite the undervalued yen on most metrics, Japan continues to run a trade deficit. The 12-month average shortfall in March was a little more than JPY145 bln. The rolling 12-month average was last positive (surplus) in October 2021. The average monthly deficit in Q1 26 was JPY162.1 bln. At the end of the week, the national April CPI is due. The Tokyo report out in late April hints at little changed to slightly firmer headline rate but it is all about fresh food and energy, without which Tokyo CPI eased to 1.9% from 2.3%. The median forecast in Bloomberg's survey was for 2.2%. Recall that the national core measure, which excludes fresh food, was below the 2% target for the second consecutive month. Meanwhile, the swaps market has almost a 75% chance of a hike discounted for next month's BOJ meeting and about the same probability of another hike before the end of the year.
Prices: The yen fell every session last week and slumped to its lowest level since the BOJ is believed to have intervened on April 30. The apparent common front offered by US Treasury Secretary Bessent and Japanese officials did not deter the market from lifting the dollar to around JPY158.65 before the weekend. Note the day before the April 30 intervention, the one-month implied volatility set a new four-year low near 6.6%. The implied three-month vol made a new four-year low early last week near 7.6%. Still the market may turn cautious as the JPY159 area is approached.
UK
Drivers: Sterling is highly correlated with the euro. Around 0.90, the rolling 60-day correlation is near the highest since the end of 2023. However, unlike the dollar, sterling moves inversely to UK rates. What is striking is not the actual correlation, which is modest at best (~0.20) but the sign. And for the record, the exchange rate is more inversely correlated with US than UK rates (~-0.45).
Data: This is an important week for UK data. It includes the data points for which investors and policymakers place much emphasis. This includes an update on the labor market, consumption (retail sales), and prices. Then there are the preliminary May PMI and April government finance figures. Before the BOE meets on June 18, it will have the May CPI in hand, but this is the last report on retail sales and employment. The swaps market has about 30% chance of a hike discounted, which is the lower end of where it has been since mid-March.
Prices: Sterling's advance from the year's low at the end of March (~$1.3160) stalled in front of $1.3660 twice earlier this month. The greenback's broad recovery and the political drama unfolding in the UK saw sterling drop every session last week. It overshot the (61.8%) retracement of the rally since the end of March, found near $1.3350. Although the momentum indicators are still falling, sterling settled below the lower Bollinger Band for the second consecutive session before the weekend. Initial support is now pegged around $1.3300. On the upside, the $1.3400-25 must be overcome to stabilize the technical tone.
Canada
Drivers: There is a US dollar-driven move now and the USD-CAD exchange rate's rolling 60-day correlation with changes in the Dollar Index has eased from the near 0.80 seen in March, the highest since July 2024, but above 0.60 is still fairly strong for it. Also, there seems to be some sensitivity to general risk appetite. Using the S&P 500 as a proxy, the correlation with changes in the exchange rate is around -0.50, which is among the most extremes it has recorded for the last couple of years.
Data: The Canadian economy is struggling. It lost almost 47k full-time positions in April, the third consecutive monthly loss. The composite PMI has risen in four of the last five months but is still below the 50 boom/bust level. StatCan reports April CPI and March retail sales in the week ahead. April CPI accelerated and the question is magnitude, and last April's 0.1% decline drops out of the 12-month comparison will amplify the increase. March retail sales are due at the end of the week. They will be flattered by the rise in prices (CPI rose 0.9% in March). The market has pushed a Bank of Canada rate hike further it. The swaps market recognizes little chance of a hike before late Q3. It is pricing in 40 bp of hikes this year, down from 60 bp earlier this month and a peak of almost 80 bp on March 20.
Prices: The US dollar begins the new week with an eight-session advance in tow. It has risen in 10 of the past 11 sessions. The gains were sufficient for it to retrace (61.8%) of its losses from the year's high recorded at the end of March near CAD1.3965. The momentum indicators suggest the greenback has more room to appreciate, though it did settle above its upper Bollinger Band. The next technical target is in the CAD1.3800-10 area. A close below CAD1.3690 could be an early sign that a top is in place.
Australia:
Drivers: The rolling 60-day inverse correlation of changes in the Australian dollar and the Dollar Index is near -0.80. It was briefly more extreme in early Q4 25 but not by much. The 60-day correlation between the exchange rate and the US two-year yield is almost -0.50, the extreme since September 2025. The Aussie's correlation with its own two-year yield is also inverse (~-0.15). Higher oil prices are correlated with a weaker Australian dollar. The inverse correlation with Brent is around -0.40. It reached -0.45 last August, which appears to be the most extreme for at least 20 years.
Data: With the third rate cut of the year delivered recently, the central bank seems to have signaled that it will pause but it is not sure that it has tightened sufficiently. The futures market has the next hike fully discounted for September. This week's data might not materially impact expectations, but the market will get some insight into how the central bank is thinking about the risks as the record of recent meeting will be published. The preliminary May PMI will likely the moderate expansion continues, but the most important report is on the labor market on Thursday. While changes in full-time employment are often volatile, it is doing well. It grew such positions by an average 26k a month in Q1, the most since Q3 24. In Q1 25, it lost about 22k full-time jobs. With one exception (September 2025), Australia's unemployment rate has been steady between 4.1% and 4.3% since the end of 2024.
Prices: The Australian dollar's consolidation was resolved to the downside at the end of last week. The Aussie had been trading within the May 6 range (~$0.7180-$0.7280 until May 15, when it was pushed to $0.7140. It settled below the 20-day moving average (~$0.7190) for the first time since April 7. The momentum indicators are curling lower. The next technical target is near $0.7100, and potential may exist toward $0.7050.
Mexico
Drivers: Changes in the US dollar-Mexican peso exchange rate and the Dollar Index are nearly 0.70 correlated over the past 60 sessions. It rarely has gotten much higher. The exchange rate is also sensitive to the changes of the two-year US yield (~0.43), the most in three years. The dollar tends to rise against the peso when oil prices are rising. The 60-day correlation is a little above 0.50, the highest in at least two decades. The exchange rate is sensitive to the overall risk environment. The 60-day rolling correlation between changes in the exchange rate and changes in the S&P 500 is around -0.75, the most in six years.
Data: The Bank of Mexico left open the possibility of a rate cut at next month's meeting. The data due in the coming days may not impact expectations. March retail sales are due, but Q1 GDP is already out, and although its 0.8% contraction could be revised this week, there is no doubt that the economy is weak. In the three months through February, retail sales were flat. And remember this in nominal in the face of CPI that is above 4%. The CPI for the first half of May likely confirmed it remained above the upper end of the target range.
Prices: The dollar jumped out of its consolidative range against the peso ahead of the weekend. The greenback poked above MXN17.40 and settled above the 20-day moving average for the first time this month. Near-term potential may extend toward the recent highs, ~MXN17.55-MXN17.58.
Reviewed by Marc Chandler
on
May 16, 2026
Rating:
