Week Ahead: Geopolitics, Tariffs, and Central Banks

[Redator]

The response of the US dollar and Treasuries to Israel's attack on Iran and the palatable risk of escalation was uninspiring. It supports the popular narrative about the changing role of the US dollar and assets in the world economy. US stocks and bond sold off ahead of the weekend. It should not be regarded as a "smoking gun" but part of an incremental addition to the accumulating evidence. The G7 meeting in Canada (June 15-17) may command attention, but if it can agree on a statement, it will be likely be so bland to express the divergence of views (and the apparent isolation of the US) that it likely have limited impact in the capital markets. The US dollar has tended to weaken when the Trump administration presses its tariff offensive. Last week, President Trump reiterated that in a week or two, letters to US trading partners will be sent that carry the new bilateral tariff. Also, Trump threatened to boost the tariff on autos, which would seem to only complicate efforts to reach trade deal with Japan and Europe. A couple of months ago, the administration was touting 90 deals in 90 days.  So far, there is one and that is with the UK, which indicated that none of it was enforceable.  Vietnam and maybe India deals could be next. 

The week ahead features several central bank meetings, including the Federal Reserve, Bank of Japan, Norway's Norges Bank, and the Bank of England. All four are likely to leave rates on hold. The Fed will update its economic projections. The Fed funds futures are not quite pricing in the two hikes that the median projection anticipated last December and March would be appropriate this year. The markets will also be looking for some guidance on the unwinding of the Fed's balance sheet (QT). The Swedish and Swiss central banks also meet. They are expected to cut key rates. A quarter-point cut would being the Swedish policy rate to 2% and could prove to be the floor. The Swiss National Bank is more interesting. The EU harmonized measure of consumer prices has fallen by 0.2% over the past 12-months. The deposit rate is at 0.25%. There is some speculation that it could return to a negative policy rate. We think this is unlikely. It is still an important threshold, and the exchange rate suggests little sense of urgency is required. 

US

Drivers:  The dollar's initial reaction to Israel's strike on Iran seemed relatively muted and this may make some question the dollar's safe haven status, and it feeds into the narrative that the dollar's role in the world economy may be changing. The FOMC meeting is important, not because it will do anything, which it will not. But what it says can still move the financial markets. The Summary of Economic Projections, even taken with a high of uncertainty, is the baseline for market. The Fed funds and swaps markets move around the median Fed projection. Yet it seems that the market converges with the Fed rather than the other way around. Trade appears to be distorting Q2 GDP but favorable unlike the large drag on Q1, but we think this is concealing a weakening of consumer demand amid the slowing of the labor market, resumption of student loan servicing, elevated debt-stress levels, and a high-degree of uncertainty. The Treasury's monthly portfolio report may be of greater interest than usual. It covers April, when the narrative hard turned to capital flight from the US, and some drew parallels between the dollar selling off despite rising rates and emerging market currencies. Within the context of the America's large net international investment position, falling asset markets and falling dollar suggests some foreign selling but the markets would have performed similarly if it were domestic, dollar-based investors diversifying offshore, too. 

Data:  Real sector due this week looks soft. The slump in auto sales (15.65 mln seasonally adjusted annual rate vs 17.27 in April) were a drag on headline retail sales though the measure that excludes auto, gasoline, building materials and food services may have risen after a 0.2% decline in April. Industrial output may have eked out a small gain in May after a flat report in April. May housing starts look little changed after a 1.6% increase in April. NY and Philadelphia June surveys will be report. There will also be much interest in the April Treasury's International Capital report given the narratives of foreign capital flight after the reciprocal tariffs were announced. Recall that in Q1 25 foreign investors bought more far more US assets than in Q1 24 (~448 bln vs $37.6). 

Prices: After falling to new three-year lows on June 12 near 97.60, the Dollar Index rebounded to about 98.60 in response to Israel's strike on Iran. It needs to overcome resistance near 98.70 to spur a return to the 99.40-100.00 area. The 20-day moving average is 99.20 and DXY has not closed above it since May 19, and the down trendline from mid-May intersects slightly above there on Monday. 

EMU

Drivers:  Late last year, the 30-day rolling correlation of changes in the exchange rate and the two-year US-German rate differential was above 0.80, a multiyear high. It fell to less than 0.10 in early June and rarely has been lower in the last few years. It is now near 0.25. Not only is the ECB well ahead of the Fed in the easing cycle, but large pools of capital seemed under-weight, the opposite of the US.

Data: The market expects a pause in the ECB's easing cycle before one more cut before the end of the year. In this context, the April current account, construction spending, and Germany's ZEW survey pose headline rise at best. 

Prices: Israel's attack on Iran halted the euro's rally after it reached slightly above $1.1630 on June 12 and snapped the four-day advance. Still, despite the setback ahead of the weekend, the June 12 low (~$1.1485) held. A break of last week's lows in the $1.1370 area is needed to signal anything important technically. The 20-day moving average is a little higher (~$1.1385) and the euro has not settled below it in almost a month. 

PRC

Drivers: There are only a handful of currencies that have been more stable against the dollar this year than the Chinese yuan. It has appreciated by about 1.75% against the dollar this year. This is not by accident. It may not always be clear how or why, but Beijing manages to deliver a fairly stable exchange rate. The growth of the US, Europe, and Japan in the 1950s and 1960s was facilitated by stable exchange rates. This proved too rigid, and Nixon's closing of the gold window was only the details of the coup de grace that was already well under way. Expect the yuan to continue to track the greenback, which means, in a falling dollar environment, it will trade softer on the crosses, making the offshore yuan a potentially attractive funding currency for carry trades.

Data: China report real sector data for May early Monday. The PMIs warn of poor data. The tariff war with the US is only adjusted toward the middle of the month, though reports suggest some container shipments were orders by US retailers before the Geneva agreement. Still, by the end of May containers activity at the west coast ports had ground to a near-halt again. Retail sales and industrial production may have slowed sequentially, house prices do not appear to have reached a bottom, but officials seem reluctant to take fresh fiscal measures or monetary measures. The loan prime rates will remain steady at 3.0% and 3.50% for the one-year and five-year tenors. 

Prices: The dollar slipped below CNH7.17 on June 12 to record the low for the week before rebounding ahead of the weekend to almost CNH7.19. The high last week was near CNH7.20. The upper end of the consolidative range is CNH7.2240-60, and a foothold above CNH7.20 would target it next. The PBOC set the dollar's reference rate at nearly a two-month low before the weekend (CNY7.1772), its lowest level in two months. It lowered the dollar's fix for the past four sessions, which limits the dollar's upside. This suggests officials are not resisting slow yuan appreciation, though we imagine their tolerance is not without limits.

Japan

Drivers:  The Bank of Japan is wrestling with trying to normalize monetary policy while the economy remains weak (-0.7% quarter-over-quarter contraction in Q1), and inflation remains elevated. As part of its effort to adjust monetary policy is it has slowed the purchases of government bonds, which appears to be adding to the pressure at the long end of the curve. At the same time, the changes in the exchange rate and in the US 10-year yield are around 0.27 over the past 60 sessions after being more than twice as high for most of Q1 25. On the other hand, the rolling 60-day correlation of the changes in the yen and Dollar Index is slightly below 0.90, the highest in 30 years.

Data:  There are two highlights in the coming days. The first is the BOJ meeting. Governor Ueda can be expected to reiterate that if the economy evolves as the central bank expects, it will raise rates further. The swaps market does not have more than 10 bp of tightening priced in until October, and even by the end of the year, the market no longer fully discounts a quarter-point hike. Recall that as recently as the end of Q1, the swaps market reflected expectations for at least 75 bp of hikes. A couple of days after the BOJ meeting, the BOJ will meet with primary dealers to ostensibly discuss supply and demand for long-term JGBS. May's CPI will also be released. Officials, like market participants, have a good idea of it from the Tokyo CPI that was reported on May 30. The headline was stable at 3.4%, but the core measure rose to 3.6% (from 3.4%) and the measure that excludes fresh food and energy rose to 3.3% (from 3.1%). The takeaway if BOJ officials, like market participants, understand that price pressures are still rising. The April national core measure, which the target of policy was at 3.5%, the highest since January 2023.

Prices:  The yen initially rallied to new highs for the week in response to news of Israel's attack on Iran but then succumbed to the broadly firmer dollar and modest rise in US interest rates. The dollar recovered from around JPY142.80 to reach almost JPY144.50, a few ticks shy of the previous day’s high. The month's high was set in the middle of last week near JPY145.45. 

UK

Drivers: Sterling was lifted to new three years highs last week, not by constructive developments in the UK, where the data mostly surprised on the downside but broadly weaker US dollar. The rolling 30-day correlation between changes in sterling and changes in the Dollar Index reached almost 0.90 and the 60-day correlation has been hovering around 0.80 for more than a month. The forward guidance from Bank of England officials had arguably persuaded market participants that the central bank will slow walk this part of the easing cycle, but the data may force its hand, even if not in the coming week. Since the end of April extreme, the swaps market has seen the expected year-end base rise slightly more nearly 35 bp before the disappointing data. It has been halved to about 17 bp above the late April low and it is falling. The 10-year Gilt yield has risen by a net of about five basis points.

Data: It is a busy week for the UK but back loaded. May CPI is due Wednesday. Utility prices jumped in April, and this was reflected in a 1.2% month-over-month surge in measures consumer prices and will not be repeated. Still, anything more than a 0.3% increase in May will lead to a higher year-over-year pace (3.5% April). The following day the Bank of England meets. There is virtually no chance of a change in policy. The base rate will remain at 4.25%. The swaps market is discounting about a 63% chance of a cut at the next meeting in August but does not have the next cut fully discounted until November. At the end of the week, May retail sales are due. They will likely slow from the heady 1.2%-1.3% increase in April.

Prices: Sterling set a new three-year high slightly before Israel's attack a little above $1.3630. It subsequently was sold to almost $1.3515, and while it took out the previous day's low (~$1.3525), it settled back within the range, neutralizing the negative technical implications. Support may extend toward last week's lows (~$1.3455-65). 

Canada

Drivers: The US dollar's broad movement appears to have eclipsed other influences on the movement of the Canadian dollar. The rolling 30- and 60 correlations of changes in the Canadian dollar and the Dollar Index are near 0.75 and 0.68, respectively, near the highest of the year. It is notable, too, that more than oil, short-term interest rates, and risk more broadly (S&P 500 as proxy) changes in the Canadian dollar are more correlated with change in gold (30-day correlation is around 0.62 and the 60-day correlation is near 0.57).

Data: The highly include April portfolio flows and retail sales. Through March, foreign investors were net sellers of about C$10 bln of Canada's stocks and bonds. In Q1 24, they were net buyers of C$24 bln Canadian assets. Still, in Q1 25, the Canadian dollar was virtually flat but in Q1 24, it fell by about 2.25%. March retail sales (0.8% month-over-month) were flattered by auto sales, without which retail sales fell by 0.7%. Early indications from StatsCan suggest that April retail sale may have risen by 0.5%. Still, this week's reports are unlikely to change market views that there less than a 1/3 chance of a Bank of Canada rate cut next month. The swaps market is discounting one cut fully in H2 25. 

Prices: The Canadian dollar was one of the two G10 currencies that appreciated against the greenback ahead of the weekend. The other being the Norwegian krone. While many cite the rally in crude oil, we note that 1) the 60-day correlation of changes in the exchange rate and oil is low (less than 0.10) and is actually slightly inverse over the past 30 days, and 2) the Canadian dollar typically does better on the crosses in a firm US dollar environment. The greenback recorded a new eight-month low ahead in the North American session ahead of the weekend near CAD1.3565. It recovered to almost CAD1.3600 in late turnover.  There appears little chart support ahead of the CAD1.3475-CAD1.3500 area, though the momentum indicators will likely be over-extended before it reaches it. 

Australia

Drivers: Over the past 30 sessions, the changes in the Australian dollar are more correlated with changes in the Dollar Index than the Canadian dollar (~0.72 vs 0.65), but the 60-day correlation is the opposite. Changes in the Australian dollar are more correlated with changes in the Canadian dollar (~0.70) than the Dollar Index (~0.55). Changes in the Aussie and gold have a 0.60 correlation over both periods. 

Data:  There is one report coming days. It is the May jobs report on June 19. The Australian labor market looks fairly stable through April. Overall, almost 104k jobs were created in the first four months of the year, down from 127k in the January-April 2024 period. Of these jobs, a little more than 2/3 (~68k) were full-time positions, down from closer to 3/4 in the first four months of 2024. The 4.1% unemployment rate is unchanged from last April, although the participation rate has risen from 66.7% to 67.1%. Ahead of the data, the futures market has about an 80% chance of another cut at next central bank meeting on July 8. 

Prices: The Australian dollar was sold to a seven-day low near $0.6455 amid the initial risk-off response to Israel's strike on Iran. However, it recovered to around $0.6515 in North America before stalling. It had recorded a seven-month high slightly shy of the $0.6550 retracement level we targeted in the middle of last week. The Aussie finished the week nearly flat.  On the year, the Australian dollar is the worst performing G10 currency with a little less than a 4.9% gain. 

Mexico

Drivers:  The Mexican peso is benefitting from a weakening US dollar, attractive carry, liquidity, and relatively low volatility. The total returns this year (carry+spot) is almost 15%. Leaving aside the Russian ruble, only three other emerging market currencies have generated a better total return (Brazilian real ~18.2%, Hungarian forint ~17.5%, and Czech koruna 15.2%). The peso's three-month implied volatility near 12.2% is near the middle of these currencies, and its liquidity is far superior.

Data: Mexico's economic calendar is extremely light in the coming days. Still, ahead of the central bank meeting on June 26, the central bank will see April retail sales and the IGAE economic activity report (similar to a monthly GDP report), May's trade balance, and the first half of June CPI. Despite the May CPI being above the upper end of the target range (2%-4%), the markets look for another (the fourth) half-point cut. Separately, Brazil and Chile's central banks meet this week. Chile's policy meeting is on June 17, a day before the FOMC meeting concludes and Brazil's central bank meeting. Chile's central bank's easing cycle began in July 2023, with its policy rate at 11.25%. It has been at 5.0% since the last rate cut in December 2024. May's inflation stood at 4.4%. Although the easing cycle may not be over, the central bank will likely remain on hold this week. On the other hand, Brazil's central bank began its tightening cycle last September and raised the Selic rate by 175 bp in 2024 and another 250 bp through last month. Softening price pressures and a weakening economy has given rise to speculation that the hikes are almost over. The swaps market is discounting one more quarter point hike.

Prices: Over the past couple of years, the peso has seen sharp dramatic selloffs on geopolitical, and more recently, tariff developments but they rarely sustained for more than a day. This may speak to the peso's use as a proxy for other less liquid emerging market currencies. The pattern was repeated before the weekend. The greenback settled near MXN18.88 on June 11 after recording a 10-month low in the middle of the week (~MXN18.8265) and spiked to around MXN19.1030 on Israel's attack. It fell back to around MXN18.8850 in North America ahead of the weekend. A break of MXN18.80 could spur a move toward MXN18.60. 

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