The Week Ahead: Disappointing US Data, Soft Two-Yield Yield Warns Dollar Leg Up on Fed's Hawkish Hold is Over

The combination of soft disappointing US data, which culminated in a jobs report on July 2 that showed half the jobs growth that was expected and the continued decline in oil prices, recognized by Fed Chair Warsh in Sintra that inflation expectations have eased recently,  took the steam from US short-term rates and the greenback. The two-year US yield finished the holiday-shortened week slightly below 4.14%. It was at 4.18% after the Fed's hawkish hold last month and peaked above 4.20%. It sounds simplistic, but in the current environment as goes the US two-year yield, so goes the dollar. 

The other story is the weakness of the Asian currencies despite the strong AI-related exports. The yen's 2.85% decline is not an outlier, but the decline has been sufficient for the yen to trade at 40-year lows. The market knows it risks intervention, and we continue to see signs in the options market that some large pools of capital have bought short-dated dollar puts to protect long dollar positions in the case of intervention. The Chinese yuan continues to stand out. The yuan's gain of a little more than 3% puts it atop the Asian currencies this year. It has also appreciated against the G10 currencies, but the Australian dollar. In the last two sessions, the PBOC set the dollar's reference rate at new three-year lows. The euro has fallen by nearly 9% against the yuan since peaking a year ago. The appreciation of the yuan is not as fast as its critics want but it is moving in the desired direction.

US

Drivers: The dollar rose in June against all world's currencies but a handful from emerging markets. To explain the decline of a few dozen currencies, one can look for idiosyncratic developments: This country is managing its currency. That country should have raised rates more aggressively. The tune may be different, but the song is the same: Strong US dollar. Last month, the US two-year yield rose by nine basis points. The comparable yield in all the other G10 countries fell (by 3-17 bp). Foreign investors have favored US equities over bonds, and they seemed to be among the bargain hunters who returned to US equities after the S&P 500 and Nasdaq fell for five consecutive sessions. 

Data: The US economy appears to have accelerated further in Q2. After slowing to 0.5% annualized pace in Q4 25 and the upward revision in Q1 25 to 2.1%, the economy appears to have grown around 2.5%-3% in the quarter that just ended. ISM's June services and the final services and composite PMI pose little more than headline risk. Net exports likely deteriorated in Q2. The goods trade deficit jumped in May and that points to the widening of the overall trade deficit, which will be reported in the week ahead. If the overall trade shortfall is in line with forecasts, ~$78 bln, the two-month average would be about $67.5 bln after an average of about $55 bln a month in Q1 26. Meanwhile, existing home sales are holding up better than new home sales. Through May, new homes sales are off about 20% this year, while existing home sales are off around 3%. The June series poses some headline risk, but Fed Chair Warsh recognized at the post-FOMC press conference that policy appears restrictive for housing even if not for the financial sector. The minutes from that Fed meeting, Warsh's first, will likely be scrutinized for insight into the new chair's style and to see how close Fed officials may be to delivering a rate hike. The Fed funds futures market has almost 21 bp tightening discounted for the October meeting. While previous Federal Reserve's might be more inclined to hike in September, when there is a new Summary of Economic Projections, Warsh wants to downgrade the SEP, and one way to do that before the taskforce report, is to raise rates without new SEP. Some members of the new taskforces are expected to be named in the coming days. 

Prices: The Dollar Index recorded the year's high on June 24 (101.80). It had been consolidating above 101.00 before the disappointing June jobs data on July 2. It fell to almost 100.55, a scratched the 20-day moving average for the first time in a little more than two weeks. The momentum indicators are turning lower. A trendline drawn off the May and June lows begins the new week near 100.30 and finishes the week closer to 100.55. DXY has already met the (50%) retracement of the rally since mid-June and the next retracement objective is near 100.30. 

EMU

Drivers: The euro continues to be highly sensitive to changes in the two-year US yield. The 30-day inverse correlation is hovering near -0.70. The most extreme reading was around the June FOMC meeting (~-0.87), which was the most extreme in more than a decade. The 60-day correlation is near -0.69. The euro's correlation with Germany's two-year yield or the two-year rate differential is considerably less (~-0.32 and -0.38, for the 30- and 60-day correlation, respectively). 

Data: The ECB hiked rates in June, and there seems to be little chance of another hike this month. This likely limits the impact of this week's high frequency data, namely, May producer prices and retail sales. Coming into May, eurozone retail sales are nearly flat in the first four months of the year. The slight softening in the preliminary June CPI takes the sting from the like rise in May's PPI. Germany's May factory orders are due on July 6 and may have stabilized after falling 3.8% in April. 

Prices: The euro bottomed on June 24 dear $1.1325. It reached almost $1.1475 in response to the disappointing US jobs report. It held below the 20-day moving average, and it has not settled above it since the day before the Fed's hawkish hold on June 17. It also stalled near the halfway mark of the euro's decline since mid-June. The next retracement objective is about $1.1510. The momentum indicators are turning higher. 

PRC

Drivers: The PBOC manages the exchange rate, but it is not random and it does not ignore market forces. The 100-day correlation between the greenback's changes against the offshore yuan and the Dollar Index is near 0.75, making it more correlated some G10 currencies. Still, we watch the daily fix for signals of potential policy changes. In the last two weeks of June, the fix was raised on a weekly basis. It is the first back-to-back increase since the end of last September and before that it was the first half of April. However, this does not seem to signal a change in policy. Indeed, the PBOC set the dollar's fix at new three-year lows last week. The PBOC has introduced a new policy tool, overnight reverse repos, and appears to have set the rate lower than expected, signaling a potential easing of other rates. 

Data:  In the management of the yuan's exchange rate, the high-frequency Chinese data seems to have little bearing. The data highlight in the coming days is China June CPI and PPI. These inflation gauges show China as exited deflations grip even as the economy appear to have weakened. In May, CPI stood at 1.2% year-over-year, and the core rate was 1.1%. They look little changed in June. Producer prices increased by 3.9% in the year through May and maybe edged a little higher in June. Yet, the disappointing real sector data has renewed some speculation that the PBOC will ease monetary policy (rate cut and possible reduction in reserve requirements). 

Prices: Last month's dollar peak against the offshore yuan was near CNH6.82, about a week after the Fed's hawkish hold. It has since pulled back. It fell in four of last week's five sessions and finished the week below CNH6.7850 and probed the 20-day moving average, which it has not settled below since the FOMC meeting. Last week, for the sixth consecutive week, the onshore yuan settled stronger than the offshore yuan. 

Japan

Drivers: Judging from the returns, one set of preferences among investors has been to favor higher interest rate currencies. Australia and Norway's policy rates are the highest in the G10 and their respectively currencies are on top through H1 26. Latam currencies have tended to do better than East Asia currencies so far this year and, while exchange rate determination is rarely mono-causal, their high rates have been an important factor. We are not convinced that another 25 or 50 bp higher rate would have changed the yen's behavior much. It would still be higher than Switzerland and below Sweden at the lower end of the G10 policy rates. 

Data:  Japan begins the new week with May labor earnings and household spending. Recall that in April real cash earnings rose 2.0% year-over-year, while household spending fell by 0.5%. Many US observers, arguably projecting their own country's experience, are bemused. Higher real income does not lead to more consumption? What gives? They underestimate the cultural roots of consumption. It has to be learned and is part of range of cultural values. For several months this year, US personal consumption expenditures increases have outstripped increase in income, the opposite of Japan's experience. The following day, Japan reports May current account. Japan runs a chronic current account surplus but has been experiencing a trade deficit despite the undervalued yen on most models of valuation. Still, Japan's rolling trade deficit has been shrinking, and on a balance of payment basis, the 12-month average has returned to surplus starting in January this year for the first time in four years. At the end of the week, Japan's June PPI will be reported. It rose 6.3% year-over-year in May, though in the first five months of the year, Japan's producer price index rose at an annualized pace of around 11.75%. 

Prices: The combination of fear of material intervention and the softer than expected US jobs report weighed om the greenback for the past two sessions. The dollar peaked on July 1 near JPY162.85, a 40-year high. Before the weekend, it reached JPY160.50 but settled back above JPY161, and the 20-day moving average (~JPY161.15). The momentum indicators are rolling over, but dollar buyers emerging on the pullback and there does not appear to have been intervention. One-month vol finished near 7.15%, up from 6.85% the previous week. The one-month risk reversal (call/put pricing skew) showed the premium for dollar puts rose to about 1.5% last week, up from about 1.1% the previous week. The high vol is consistent with option buying and the large put premium suggests dollar puts are being bought. 

UK

Drivers: The UK quit the EU a decade ago last month, and yet over the past 100 sessions, the changes in sterling and the euro have a 0.87 correlation, which is higher than the correlation when the referendum was held (0.45). What is also remarkable is that sterling is more correlated to the euro than the Swiss franc (~0.80). The Swedish krona enjoys around the same correlation with the euro as sterling over the past 100 sessions. 

Data: The main data point from the UK in the coming days, June construction PMI is due Monday. It has not been above the 50 boom/bust level since the end of 2024. It was 40.1 at the end of last year and 38.2 in May. It is the lowest since the pandemic. The Labour Party's leadership contest begins formally in the coming days, but there seems to be little doubt that Andrew Burnham will replace Keir Starmer and become the seventh prime minister in the decade since the Brexit Referendum, which is a useful mile marker, but the Brexit decision does not satisfactorily explain the turnover, e.g., Johnson, Truss, and Starmer.

Prices: Sterling bottomed on June 24 near $1.3140. Last week it reached about $1.3385, its best level since the FOMC meeting. It took out the line connecting the mid-May and mid-June highs in the last two sessions but was unable to settle above it. The trendline is found slightly below $1.3350 on Monday and it is closer to $1.3315 at the end of next week. The 200-day moving average is near $1.34, and sterling has not settled above it since the day before the FOMC decision. The $1.34 area also holds the (50%) retracement of sterling's decline since the May 1 high (~$1.3660). The five-day moving average is poised to move above the 20-day moving average for the first time since mid-May. 

Canada

Drivers:  In the current environment the Canadian dollar tends to do better when short-term Canadian rates are falling. This may seem counter-intuitive, but the 30-day correlation between changes in the US dollar's exchange rate against the Canadian dollar was positive in Q2 26 and mostly inversely correlated in the first quarter. Still, the best thing for the Canadian dollar is a weaker dollar more broadly. The 30-day correlation between DXY and US vs. CAD is a little below 0.70. 

Data: It is a big week for Canada's high frequency data. The June services and composite PMI and the Ivey iteration are due. These surveys appear to be faring better than the hard data suggests. The central bank's Q2 business survey is due at the start of the week as well. The highlight of the week is at the end of the week with the June jobs report. It is difficult to envisage a better report than May's when the unemployment rate fell to 6.6% from 6.9% and Canada created 154k full-time posts (lost 66.2k part-time jobs). The Bank of Canada meets on July 15, and the policy dilemma Governor Macklem acknowledged suggests an extend pause remains the most likely scenario. Lastly, Canada announced the beginning of a new oil pipeline that will have the capacity to send 1 mln barrels a day to Asia, as it seeks to diversify away from the US. 

Prices: The greenback approached CAD1.4250 last week, matching the high from the previous week. It pulled back to about CAD1.4150, an eight-day low after the US employment report. However, the US dollar bulls have not given up. The greenback finished the week slightly above CAD1.42. The momentum indicators look stretched, but support in the CAD1.4100-CAD1.4135 must be taken out to boost the chance a top is in place. If not, the near-term risk extends toward CAD1.4300. 

Australia

Drivers: Unlike the Canadian dollar, changes in the Australian dollar's exchange rate are positively correlated with changes in Australia's two-year yield. Yet, at less than 0.15 and 0.25, respectively, the 30- and 60-day correlations are not inspiring. The inverse correlation between changes in the US two-year yield and the Aussie's exchange rate is ~-0.55 and ~-0.65 for the past 30- and 60-sessions, respectively. 

Data: Australia's data calendar is practically empty this week outside of the Melbourne Institute's (experimental) inflation gauge. It fell by 0.3% in May though rose at an annualized rate in the first five months of the year of almost 3.5% compared with a 4.4% year-over-year pace. The Reserve Bank of Australia does not meet until August 11. The odds of a rate hike this year have diminished, but we suspect it is near a bottom. At the end of May, the futures market has almost 18 bp of tightening discounted in the remainder of the year. At the end of June, about 10 bp of tightening was priced in, and now almost 15 bp.

Prices: The Australian dollar posted a key upside reversal last Tuesday by making a new low since early April, slightly above the 200-day moving average (~$0.6865) and recovering to settled above the previous day's high. There was no immediate follow-through buying, but at the end of the week, it tested $0.6950, an eight-day high, its best level since the softer than expected May CPI. The $0.6950 area corresponds to the (38.2%) retracement since the June 15 high (~$0.7080). The next retracement and the 20-day moving average around found slightly above $0.6975. More formidable resistance is seen around $0.7000. The momentum indicators are turning up but are still in oversold territory. 

Mexico

Drivers: The dollar's movement against the Mexican peso is more correlated with JP Morgan's Emerging Market Currency Index (~0.80) than the Dollar Index (0.74) over the past 30 sessions. The 60-day correlations are about 0.81 and 0.66, respectively. MSCI has an emerging market currency index but the correlations with the dollar-peso are considerably weaker. 

Data: Mexico's June CPI will released on Thursday. Headline inflation is running slightly inside the broad 2%-4% target, while the core rate is slightly above. The central bank has been somewhat more concerned about economic weakness, but it looks as if the economy has gained some traction. On Friday, Mexico reports May industrial output. It surged 2.1% in April, the strongest since March 2021. Manufacturing's gain (1.2%) and construction (7.6%) more than offset the decline in mining (-0.7%) and utilities (-0.3%). The minutes from the recent central bank meeting (it stood pat) will be released on Thursday. The swaps market is discounting the next move, a hike, by late this year. 

Prices: The US dollar peaked against the peso on June 24 near MXN17.6765. It was its best level since early April. It has subsequently pulled back and briefly slipped below MXN17.42 ahead of the weekend; its lowest level since June 23. That area also corresponds to the halfway mark of the greenback's gains since the June 15 low (~MXN17.1575) and the 20-day moving average. The next retracement is near MXN17.3550. The US dollar looks toppish against the Brazilian real near BRL5.20-BRL5.22. The Colombian peso continues to bask in the political shift to the right. It was the best performing currency in the world last week, with a 3.7% gain and it reached its best level in six years. 

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