Dollar Drop Gains Momentum and US Rates Extend Decline

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Overview: An accelerated run on the US dollar continues. The euro, sterling, Australian and New Zealand dollars have risen to new highs. The greenback has dropped to new lows since 2015 against the Swiss franc. Japan's efforts to protect its rice farmers triggered the ire of President Trump. The "reciprocal tariffs," which could come back to the fore in a week, would be around 24% on Japan if no agreement is struck. While all the G10 currencies are firmer today, the yen leads with around a 0.75% gain. In addition to the trade disruption, a drag is coming from the decline in US rates. The 2- and 10-year yields are at new two-month lows. All but a few emerging market currencies are higher today, led by the 1.4% jump in the Taiwanese dollar as life insurance companies reportedly boosted hedge ratios. 

Outside of Japan and Australia, Asia Pacific equities advanced. Three markets rose more than 1% (New Zealand, Taiwan, and Thailand). Europe's Stoxx 600 is off about 0.2% after the 0.4% loss yesterday. US index futures are slightly underwater too. Bonds are bid. Benchmark 10-year rates tumbled 4-5 bp Japan and the Antipodeans. European rates are also mostly 4-5 bp lower. The 10-year US Treasury yield is off a little more than three basis points and is slightly below 4.20%. The weaker dollar and lower rates are helping gold extend yesterday's recovery from low since May 20 (~$3249) to $3346 today. August WTI is confined to a narrow range of a little more than 30 cents on either side of $65. 

USD: The Dollar Index succumbed to the selling pressure, perhaps encouraged by continued decline in US rates. It recorded a new since late Q1 22 (~96.45). The two-year yield is off around 30 bp since June 16. The market is getting more aggressive about the trajectory of Fed policy. The Fed funds futures are discounting 68 bp of cuts this year--two cuts fully and a 70% chance of a third, with four meetings left, and nine Fed officials two weeks ago, suggesting none or one cut would be appropriate this year. The year-end effective funds rate is seen near 3.65%, the lowest since early May. From the mid-May highs, the Dollar Index has been trending lower in a band. The upper end is near 98.95 and the lower end is near 96.50 (falling to around 94.65 on July 31). Meanwhile, the S&P 500 and NASDAQ reached new record highs yesterday. The gap between European stocks and the S&P 500 has narrowed. Consider that in June, the S&P 500 rose by nearly 5.0% while Europe's Stoxx 600 was off by 1.3%. Today's final July manufacturing PMI and the ISM manufacturing index may have limited impact, given the Federal Reserve's reaction function, which is now putting more emphasis on real sector data. The manufacturing PMI has been above the 50 boom/bust level this year after being below it in H2 24. It is seen little changed from the 52.0 seen in May and June. In contrast, the manufacturing ISM has been below 50 since October 2022 with the brief exception this past January and February. It has been hovering below 49.0 in April-May. This is expected to have continued to be the case last month. The US also reports May construction spending. The median forecast in Bloomberg's survey expected the fourth consecutive month decline, something not seen since 2018. The May JOLTS report is expected to show a modest decline in job openings. Auto sales will trickle in over the course of the session, but another decline is expected (the third in a row after the surge in March to beat the tariffs). Still, it is another data point that indicates the US consumer is pulling back. 

EURO: The euro extended its gains to $1.1830 today, a new high since September 2021. It last fell on June 17, two weeks ago. It posted its fourth consecutive close above the upper Bollinger Band (found near $1.1800 today). Options for 2 bln euros struck at $1.18 expire today. The next chart area of note is around $1.1850, but many are targeting the $1.20 area. With US stocks and bonds rallying, it is hard to make the argument that the dollar's decline is a function of the sale of US assets. The BIS suggested that the decline in Q1 may have been more related to hedging dollar exposure. Watch the five-day moving average. It is near $1.1735 today, and the euro has not closed below it since June 19. The final eurozone's June manufacturing PMI was 49.5 (49.4 initial estimate, unchanged from May). With the revisions, it has extended the recovery for the sixth month but still remains below the 50 boom/bust levels. The preliminary June CPI estimate showed a 0.3% increase, which lifted the year-over-year rate to 2.0% (from 1.9%). The core rate was unchanged at 2.3%. The ECB survey found one- and three-year CPI expectations in May eased to 2.8% (from 3.15) and 2.4% (from were 3.1%), respectively. 

CNY: The dollar continues to chop in its recent trough against the offshore yuan and reached a marginal new low of almost CNH7.15. A break of CNH7.15 could target CNH7.10 next, but assuming continued US dollar weakness, a move CNH7.00 seems reasonable. Yesterday, it settled below last Friday's low (~CNH7.1620). The PBOC has steadily lowered the dollar fix in June, though today's was CNY7.1534 (CNY7.1586 yesterday), the lowest since November 2024. At the end of May, the reference rate was CNH7.1848. It was the second consecutive monthly decline. Until the PBOC is more obviously rejecting the strengthening of the yuan, the market may continue to press for the official pain threshold. That said, last week's quarterly policy statement from the PBOC dropped the reference to its intention to "cut interest rates and lower the reserve requirement ratio." Meanwhile, China's two manufacturing PMI measures have diverged. The version of the China's Federation of Logistics and Purchasing has mostly under-performed the Caixin iteration. The former rose to 49.7 in June and averaged 49.4 in Q2 after 49.9 average in Q1. Caixin's manufacturing PMI rose to 50.4 in June from 48.3 in May. It averaged 49.7 in Q2 and 50.7 in Q1.

JPY: After setting session highs in early North American trading yesterday near JPY144.75, the greenback was sold slightly through JPY144.00 in the NY afternoon. It has fallen to almost JPY142.80 today, and in the process, took out the trendline drawn off the April 22 low and the June 13 low (~JPY143.60 today). And we argue, not coincidentally, the 10-year US yield slipped below 4.20%, for the first time since early May. Japan's economy contracted by 0.2% at an annualized rate in Q1 and the median forecast in Bloomberg's survey is for a 0.3% expansion in Q2. Both point to a virtually stagnant economy. Real sector data has frequently disappointed, and the Bloomberg real sector surprise index fell to its lowest level in Q2. Yesterday's disappointing May industrial output (0.5% vs. 3.5% median forecast in Bloomberg's survey) and a dramatic 34.4% year-over-year decline in housing starts fit the pattern. Earlier today, the Tankan survey was released. Sentiment mostly weakened slightly except for the large manufacturers, which saw a small rise (13 vs. 12), though of note capex plans increased (11.5% vs. 3.1% in the Q1 survey, which is stronger than expected). Among the large firms, inflation was seen at 2.3% on a five-year projection, which feeds into the BOJ's assessment of long-term inflation expectations. Separately, the Japan Times reported that 195 major food makers expect to raise prices on over 2000 products in July, a five-fold increase from a year ago. Lastly, the final June manufacturing PMI was 50.1 (50.4 flash) and was still the first reading above 50 since last June. 

GBP: Sterling struggled yesterday but settled slightly firmer near $1.3730. Still, the weak dollar casts a pall over the forex market in general. It is fraying the upper end of last Thursday's range (~$1.3770) and reached almost $1.3785 in European turnover today. The next notable chart area is around $1.3830. The UK's June manufacturing PMI was confirmed at 47.7 and it is the third consecutive monthly increase. It was last above 50 in September 2024. Separately, attributable to the stamp duty increase, Nationwide reported a 0.8% decline in house prices in June, the largest drop since February 2023. Also, commanding attention is today’s vote in the House of Commons on the Universal Credit and Personal Independence Payment Bill--the major disability reform legislation---seen later today. An estimated 120 Labour MPs were threatening to vote against the government, which has a 165-seat majority before Prime Minister's Starmer's compromise. Some reports suggest 50-60 Labour MPs may still not vote with their government. At the same time, some polls suggest Nigel Farage's Reform UK party leads in the opinion polls. 

CAD:  With the resumption of US-Canada trade talks and the broad weaker greenback, the Canadian dollar pushed through last week's lows to CAD1.3600 yesterday, which it has taken out today. Options for $330 mln expire today at CAD1.3600. The break of CAD1.3600 targets the year's low (~CAD1.3540) set last month. Canadian markets are closed today for Canada Day. The June manufacturing PMI will be reported tomorrow. It was 51.6 in January after finishing 2024 at the year's high 52.2 (the highest since February 2023) and fell to 45.3 in April, a multi-year low. It recovered to 46.1 in May, which is still below all of 2024 readings.

AUD: The Australian dollar, which spiked below $0.6400 last Monday, rose to almost $0.6585 in North America yesterday and to $0.6590 today. The $0.6600-20 area may offer some resistance; but momentum traders may have their sights set on $0.6680-$0.6700. The Aussie has been fraying the upper Bollinger Band and settled above it yesterday. It is found near $0.6580 today. Australia's manufacturing PMI has not been below 50 in H1 25 but has now softened for three consecutive months. The final June reading was 50.6 down from 51.0 preliminary estimate (51.0 in May). Still, it averaged 51.1 in Q2 and 50.9 in Q1. These are the first quarterly averages above 50 since the end of 2022.

MXN: Today has the makings for the sixth consecutive session that the US dollar will record lower highs and lower lows against the Mexican peso. A new dollar low since last August was recorded today near MXN18.6875. We suggested a break of MXN18.80 could see MXN18.60 next and that still seems reasonable. Over the medium-term, potential may extend toward MXN18.35. There are options for $700 mln at MXN18.65 that expire today. The greenback was sold to almost BRL5.42 yesterday, its lowest level since last October. Between the currency and rate pick-up, the Brazilian real generated a 21.3% return in H1. The Mexican peso has generated a 16.3% total return for dollar-based investors. Mexico sees the June manufacturing PMI today and the IMEF surveys, which are similar to the PMI. Illustrating the weakness of the economy, which led Banxico to deliver its fourth consecutive half-point cut last week, the manufacturing PMI has not been above 50 since last June. The average through May has been 46.9. It was at 46.7 in May, recovering from a multi-year low of 44.8 in April. The IMEF manufacturing survey has been below 50 since last March, and the non-manufacturing survey has not been above 50 since last August. May worker remittances are due. They are the largest source of hard currency for Mexico but appear to be slowing. Through April, remittances totaled $19 bln, which is about $500 mln less than the same year ago period. It is not significant yet, but the budget proposals include a new tax (3.5% rather than 5). It is the first federal tax of its kind and estimates put the total remittances from the US above $80 bln. Mexico President Sheinbaum said at here daily press conference that the US tax on worker remittances by Mexican workers would be 1% and would only apply to cash not electronic transfers. She estimated that 99% of the remittances to Mexico are sent electronically. Mexico will shortly announce a program to reimburse the remittance tax to people who send cash through the Finabien Card (pre-paid debit card issued by the Mexican government). 

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