The August lull is a myth—a mirage for those who mistake heat for inertia. As this summer advances, businesses and investors should brace for turbulence, not tranquility. A kaleidoscope of US tariffs, an escalation of Russia's assault on Ukraine ahead of the American deadline, deceleration of US growth, when looking through the trade-related distortion, and the de-synchronization of the monetary cycle, weave together a narrative far more dramatic than Northern Hemisphere’s summer doldrums. Market participants and policymakers alike will be navigating a landscape increasingly defined by disruption and divergence, with the potential for unforeseen consequences echoing across continents.
Universal Tariffs: What Emergency
U.S. “universal tariffs” and threats of "secondary tariffs” in a broad, unambiguous signal that the world’s largest economy is unilaterally and idiosyncratically rewriting the rules. This is not the bureaucratic fine-tuning of trade frameworks; it is the imposition of an economic and financial cudgel. The politics are clear: force the rearrangement of global supply chains to favor domestic producers, even at the risk of collateral damage. Use the US leverage to demand other, non-trade related concessions.
It is if an emperor in a past age, with coffers running low at home, sends out his men to shakedown the colonies and extract greater tribute. The 50% tariff threatened on Brazil, which runs a small trade deficit with the US removes any veneer about the efforts to balance trade.
It is a weapon the US President seems to be able to wield freely. Congress is still not reasserting its constitutional and historic role in regulating international commerce. The appeal to the international trade court case that ruled President Trump was over-reaching his authority under the International Emergency Economic Powers Act was heard at the end of last month. A judgement could be delivered in the coming weeks, which itself will be appealed.
While the executive needs a wide berth to be able to define a national emergency, whether Canada, like the UK and France, recognize Palestine next month does not reach that bar. Nor does the judicial treatment of former Brazil President Bolsonaro. The US has recorded a sustained, and sometimes large, current account deficit for more than 40 years. Does it constitute an emergency, or has the Trump administration pulled the fire alarm because it is a lever of power that Congress has abdicated, and seems not to believe the judiciary can force its will on the executive branch?
US Labor Market Headwinds Strengthen
After a period of resilient US job growth, recent data now point to unmistakable signs of cooling. Whether it is a modest uptick in unemployment, waning wage gains, or softening job openings, the indicators collectively suggest a labor market losing momentum. The gap "jobs hard to get" and "plentiful" from the Conference Board's survey appears to be reaching a tipping point.
The labor market, once the anchor for U.S. growth, now looks more like a weathervane, shifting with the prevailing winds. The stunning weakness of the US July jobs data likely signals the end of the month-long dollar bounce. Attention turns this year’s Jackson Hole Economic Policy Symposium later in August, where central bankers, economists, and market participants gather to discuss policy. The theme is "labor markets in transition."
Although the Federal Reserve cut rates in Q4 24, it has been on hold this year, and it has done so practically unanimously until the two governors (Christopher Waller and Michelle Bowman) dissented last month. It was the first dissent by two governors since 1993. They were concerned that the labor market was weakening and the inflation from the tariffs was unlikely to be sustained, and that correct policy stance is neutral.
Still, the majority of the Federal Reserve Open Market Committee accepted Chair Powell’s framing of the issue: The economy and the labor market were sufficiently strong to allow the restrictive policy push inflation closer to target. It seems like an issue of timing. We suspect the labor market weakness will spur the Fed to resume its easing cycle as early as next month.
Ironically, the timing may roughly coincide with President Trump’s nomination to replace Governor Adriana Kugler, whose term ends in January. It will spur speculation if that nominee will also be the administration’s choice as a successor to Powell, whose term as governor does not end until January 2028. A nominee that Powell may think threatens the independence of the institution may encourage him to remain on the board as governor, quite a turn on the shadow Fed chair that some officials floated previously.
Divergence in Motion: BoE and RBA Step Forward
While the Fed hesitates, others act. The Bank of England and Reserve Bank of Australia are set to deliver rate cuts this month. Both confront softening growth, and the swaps market anticipate another cut in Q4. In addition to the BOE and RBA, the easing cycles are seen carrying into next year for the Reserve Bank of New Zealand and Norway’s Norges Bank.
However, the rate cut cycles of other G10 central banks are approaching what the swaps market is pricing as terminal rates. The European Central Bank the Swiss National Bank, the Bank of Canada, and Sweden’s Riksbank are seen to be maybe one cut away from the end of their cycles.
Eleven of the 19 FOMC members estimated that the neutral rate for Fed funds (r*) is 3% or below. With the current target at 4.25%-4.50%, the Federal Reserve has greater scope to cut rates than other G10 central banks. The Fed funds futures market is currently pricing an end of 2026 effective Fed funds rate of 3.08%.
China: Quietly Redrawing the Map
The US and China reached an agreement in late July to extend the "tariff truce." It was initially to end on August 12 and looks likely to be extended for another 90 days. In addition to the reduced tariffs, there appears to be tangible results. China's data suggest its outbound shipment of rare earths soared in June after the May's trickle (660% month-over-month). The US granted Nvidia the authorization to sell the H20 chips to China.
The US has also cancelled a meeting with Taiwan's defense minister, which was unusual in the first place, and dis-invited Taiwan President Lai Ching-te from stopping in the US on part of a larger trip to Latin America. Another challenge looms on the near-term horizon. Taipei is seeking a $20 bln arms deal in 2026.
While the West publicly reconfigures supply chains and tariffs dominate headlines, China is playing a longer, subtler game. A surge in the June trade surplus underscores Beijing’s ongoing manufacturing clout. But China’s true move comes not in trade surpluses, but in tightening its grip on advanced technologies. China exports almost 20% of its GDP, which is a smaller share than most G10 countries.
July’s new export license requirements for key EV battery components are more than regulatory tinkering; they are a calculated escalation. Lithium-ion chemistries, advanced electrolytes—these are not just inputs, but strategic levers. China’s message is pointed: any attempt to decouple comes with high, real-time costs. It calls into question Ford's plan to build at an EV battery plant in Michigan that was planning on licensing Chinese technology.
There is another layer as well: China’s expanding Belt and Road strategy and aggressive digital infrastructure outreach quietly reshape the global South, offering alternatives to U.S.-led frameworks. As America’s posture grows confrontational, China’s pitch—stability through partnership—resonates with nations seeking autonomy from the dollar-centric order.
August as a Crucible
All told, August isn’t about summer slowness, it’s a crucible moment for the global economy: Universal tariffs, Russia's war on Ukraine continues as does the conflict in the Middle East, rising nationalism and militarism, while the two largest economies feel their way around supply chain dominance in the name of statecraft.
Investors should prepare themselves for turbulence, not just in commodities and currencies but in the very assumptions undergirding supply chains and policy. This is a world where lines between the short-term and structural, the domestic and international, blur by the week. Markets will reward those who stay vigilant, nimble, and unsentimental about old certainties. The stage is set not for a return to stasis, but for another phase in the recalibration of globalization itself.
Bannockburn World Currency Index
Bannockburn's World Currency Index is a GDP-weighted index of the currencies of the dozen largest economies, as it turns out, evenly divided between high income and emerging market currencies. It posted its first monthly decline of the year as the other 11 currencies fell against the dollar. The 1.3% decline offset the gains recorded in May and June. It fell to around 95.50 and that could prove to be the low before the uptrend resumes.
The currency that fell the least in the basket was the Chinese yuan. It fell 0.5%. Among the broader emerging market currency complex, the only currency that did better than the Chinese yuan was the Hong Kong dollar, which is pegged to the greenback. The Mexican peso, a market favorite, fell by a little less than 0.7% and was the only other currency in the BWCI that fell by less than 1.0%.
On the other hand, the Japanese yen was the poorest performer in the BWCI. It fell by about 4.4% in July, the third consecutive monthly decline. The euro, sterling, and the Brazilian real fell by 3% or more. The other constituents BWCI, the Australian dollar, the Indian rupee, the Russian ruble, and the South Korean won fell by 2.1%-2.85%.
Based on the World Bank's report on the previous year's GDP, we adjust the weights of Bannockburn's World Currency Index. The adjustments are typically minor. That was the case this year. The biggest changes were the US dollar's weight edged up to about 33.25% (from 32.90%). and the yen's weight was reduced to about 4.6% (from 5.0%). Among emerging market currencies, the yuan, Brazilian real, and South Korean won's weights were shaved, while India's rupee, Russian ruble, and Mexican peso's weight crept up slightly. Overall, the weight of the currencies from high income countries and emerging market currencies was nearly flat, slightly below 2/3.
U.S. Dollar: The dollar's rally in July was predicated on a rise in US rates and economic data that proved more resilient than expected. That ended dramatically with the disappointing US July jobs report. A break of the 97.85 area in the Dollar Index could signal a resumption of the greenback's downtrend. The weakness in job growth and the rise in the unemployment rate illustrates the concerns expressed by the two dissenting Fed governors about the labor market growth stalling. Raising household debt stress levels, slowing hiring, and the rising prices of goods, associated with the tariff may weigh on consumption, a key engine of growth. The distortions associated with trade and inventories injected volatility into US GDP in the first two quarters of the year, but growth is expected to slow in the second half. We look for two rate cuts and suspect there is a greater chance of three cuts than one. US tariff revenue through July was about $126 bln, compared with around $55 bln in the same period in 2024. Many, if not most, economists, understand the tariffs to be largely a tax on consumption, and the replenishing of the Treasury's General Account, after it was run down as the debt-ceiling approached earlier this will also tighten financial conditions. Despite the tariff revenue, the US budget deficit may widen from $1.8 trillion in 2024 (~6.4% of GDP).
Euro: The euro snapped a six-month rally in July and fell by almost 3.2%. It fell from almost a four-year high on July 1, near $1.1830 to almost $1.1400 at the end of the month. While this fell shy of technical retracement levels, the downside correction may have ended. Our year-end target of $1.20 still seems reasonable and may still prove to be conservative. The increased prospect of a Fed cut in September seems to have helped it forge a low. The dramatic change in US policy and the uncertainty emanating from it arguably means that investors will demand a higher interest rate premium to hold on to dollars. As of August 1, the US two-year premium over Germany fell to near a four-month low close to 180 bp. It spent most of July above 200 bp. The derivative market is pricing in about 15 bp of easing by the ECB in the remainder of the year (60% of a cut) while it has moved to a discount of a little more than 50 bp of cuts by the Federal Reserve. The 15% tariff the US has imposed apparently includes autos and pharma but not metals. The other details of the other elements, like $750 bln purchases of US energy and $600 bln in direct investment, do not appear to have been worked out yet. And even then, it requires a qualified majority of countries (55% of the member states, or 15 of the 27 countries, and representing 65% of the total EU population) and the European Parliament to approve. This will be no easy matter.
(As of August 1, indicative closing prices, previous in parentheses)
Spot: $1.1587 ($1.1718) Median Bloomberg One-month forecast: $1.1648 ($1.1635) One-month forward: $1.1611 ($1.1743) One-month implied vol: 7.7% (8.3%)
Japanese Yen: After falling for the first four months of the year, the dollar rose for its third consecutive month against the Japanese yen in July. The yen was the weakest G10 currency last month, falling by about 4.4%, which left it up around 4.0% year-to-date. The dollar looks to have peaked near JPY151 before the US employment data. We see potential toward back to JPY145 in the coming week as the market has the weakness of the labor market caps US interest rates. The dollar's movement against the yen is strongly influenced by two factors-its overall direction and the US 10-year Treasury yield. Changes in the exchange rate and the Dollar Index have about a 0.85 correlation over the last 30 and 60 sessions. Changes in the exchange rate and that 10-year US yield is slightly above 0.75 in the past 30 sessions and slightly below 0.55 over the past 60 sessions. Although the US and Japan appear to have reached a trade agreement that applies a 15% levy on Japan's imports to the US, including auto and parts, which account for around 80% of Japan's trade surplus with the US. There seems to be less agreement regarding the $550 bln (14% of Japan's GDP) direct investment that the US says Japan promised. Japan will continue to import rice from the US under its quota system and will not impose new safety regulations on US autos imports. US autos tend to be larger and less fuel efficient than Japanese consumers want. After losing the lower house majority in 2024 and the upper house majority last month, pressure to replace Prime Minister Ishiba seems to be intensifying.
Spot: JPY147.40 (JPY144.65) Median Bloomberg One-month forecast: JPY143.65 (JPY145.55) One-month forward: JPY146.90 (JPY144.15). One-month implied vol: 9.4% (10.0%)
British Pound: Sterling reach almost $1.3790 in early July, its best level since October 2021. However, the broader US dollar recovery and a series of disappointing UK data took sterling to around $1.3140 before the US employment data on August 1, its lowest level since mid-May at the end of July. That may market the bottom of sterling's pullback. A move above $1.3400 could target $1.36 next as it works its way higher. While the market is confident that the Bank of England will cut rates at the August 7 meeting (~94%), which will bring the base rate to 4.00%. The swaps are fully pricing in a cut in Q4. The swaps market has a terminal rate near 3.50%. The poor economic performance serves to aggravate the fiscal straits of the government, but this may not reach a head until the budget in the fall. Ideas to use confiscated crypto may help on the margins but will not address the underlying challenges. The Labour government seems to the right Labour MPs in Parliament. The Conservatives also seem split. This appears to be allowing Nigel Farage's Reform UK Party to continue to make headway.
Spot: $1.3279 ($1.3715) Median Bloomberg One-month forecast: $1.3454 ($1.3635) One-month forward: $1.3285 ($1.3720) One-month implied vol: 7.3% (7.6%)
Canadian Dollar: After falling for the past five months, the US dollar rose by about 1.8% against the Canadian dollar is July. It initially tested the lower end of a two-month range, falling to around CAD1.3555 before recovering to a two-month high near CAD1.3880 in late July. The chief driver is the overall direction of the greenback more broadly rather than local developments in Canada. The rolling 30-day correlation between changes in the exchange rate and the Dollar Index is slightly above 0.75. Recall that in early February, the 30-day correlation briefly was below 0.20, the lowest since August 2023. The Bank of Canada met in late July and left policy on hold. It holds out the possibility that after front-loading rate cuts, there may be scope for another one. The swaps market is unsure that it will be delivered this year, even though economists anticipate that the economy contracted in Q2 and will likely stagnate in Q3. The swaps market is discounting about an 87% chance of a cut before the end of the year and does not have a cut fully discounted even next year. Canada's strategy to address the shock coming from the US seems two-fold. First, it diversifies trade away from the US and strengthens relations with Europe, and second is to reduce internal barriers to trade between provinces. The OECD's model of purchasing power parity has the Canadian dollar the third most under-valued currency within the G10 at nearly 21% behind the Japanese yen and euro. It estimates fair value at CAD1.14. This seems like a stretch, but potential may exist toward CAD1.31-CAD1.34 next year.
Spot: CAD1.3786 (CAD 1.3690) Median Bloomberg One-month forecast: CAD1.3739 (CAD1.3695) One-month forward: CAD1.3765 (CAD1.3670) One-month implied vol: 5.0% (6.1%)
Australian Dollar: After cutting rates in February and May, the Reserve Bank of Australia surprised market participants by standing pat in July (overnight cash target 3.85%). RBA Governor Bullock stressed that the easing cycle was not over, but the central bank was committed to a gradual course and a further moderation of price pressures is needed. The Q2 CPI, reported at the end of July, in fact, eased to 2.2% year-over-year from 2.4% in Q1. It is the lowest since Q1 21. The futures market anticipates a cut at the August 12 meeting (~93%) and at least one more cut in Q4. The swaps market anticipates a terminal rate between 3.0% and 3.25%. The Australian dollar reached a new high for the year in late July near $0.6625. The upside momentum stalled, and the Australian dollar finished July with around a 2.4% loss, among the least in the G10. It was the first monthly loss since February. It found support ahead of $0.6400 in late July. Provided it holds, we look for the Australian dollar to recover. A move above $0.6550 would boost the chances of a resumption of the uptrend.
Spot: $0.6474 ($0.6530) Median Bloomberg One-month forecast: $0.6488 ($0.6520) One-month forward: $0.6490 ($0.6535) One-month implied vol: 9.0% (10.1%)
Mexican Peso: The dollar has been trending lower since the peak near MXN21.08 in early April as threat intensified. The selling pressure pushed the greenback to a new low for the year in late July around MXN18.5250. During the downtrend, the dollar appears to have completed its fifth countertrend bounce slightly above MXN19.00 before the dismal July US jobs report. Between the spot appreciation of the peso and yield pick-up, for dollar-based investors, the peso returned about 16.8% year-to-date. While a few other emerging market currencies, including the Hungarian forint and Brazilian real have generated superior returns (closer to 20%), the lower peso volatility and practically 24-hour a day liquidity illustrates why it is a favorite long of carry-trade strategies of levered pools of capital. We expect the dollar's downtrend to resume and target the MXN18.35-40 area next. Mexico's economy is growing slowly, the underlying strength of the peso and news that headline inflation fell below 4% in the first half of July, back within the target range for the first time since the end of April, have encouraged speculation of a rate cut at the August 7 central bank meeting.
Spot: MXN18.8595 (MXN18.8240) Median Bloomberg One-month forecast: MXN18.9359 (MXN19.5285) One-month forward: MXN18.9227 (MXN18.89) One-month implied vol: 8.5% (9.6%)
Chinese Yuan: The yuan rose to a marginal new high for the year against the dollar in July and the PBOC continued to moderate its gains primarily through setting the daily setting of the dollar's reference rate. Officials continue to show a little more flexibility in setting that reference rate, and its average daily change is more than seen in the first couple months of the year. Despite tariffs levied on China by the US and others, China reported a Q2 trade surplus of almost $314 bln, a record, after a $272 bln surplus in Q1 (and $252 bln in Q2 24). China estimated Q2 GDP at 5.2% year-over-year but even if the estimate were not suspect, the quality is with the property sector still a drag on prices, wealth effect, consumption, and profits. We have consistently argued that China suffers from over-investment rather than under-consumption. Consumption has been rising in China faster than in most countries, but investment has been rising too, and this has kept their proportions to GDP out of balance. A new word crept into the lexicon in July, "anti-involution" which is essentially about the pressure on prices and profits stemming from over-investment. In part, we trace it to Chinese businesses access to patient capital (state-owned bank lending), which supports competition for market share rather than profits. In addition, the decentralized planning on the local government level and the competition for the rewards of success lead to provinces pouring investment into new opportunities (e.g., steel, solar panels, AI, EVs, batteries, etc.).
Spot: CNY7.1933 (CNY7.1725) Median Bloomberg One-month forecast: CNY7.1861 (CNY7.1830) One-month forward: CNY7.1450 (CNY7.1455) One-month implied vol: 5.1% (4.8%)
Reviewed by Marc Chandler
on
August 02, 2025
Rating:
