Week Ahead: US CPI and Import Prices may keep Fed's Stand Pat Decision Unanimous amid Threats of a Higher Universal Tariff

[Redator]

The dollar rose against most of the G10 currencies last week. The Australian dollar and Swedish krona were the exceptions. The Aussie was helped by the central bank's surprise decision not to cut rates. The krona may have been helped by stronger than expected June inflation, with the key measure jumping to 3.3% from 2.5%), ostensibly delaying a final rate cut in the cycle. We have been framing the recent dollar recovery as a technical correction, aided by higher US rates, of the leg down from June 23, apparently inspired at the time by more aggressive attacks on the Fed's monetary stance that has continued to be decided with no dissents. The Dollar Index rose every session last week, and in fact, it has not fallen since July 2. The US 10-year yield fell only in one session so far this month and the two-year yield twice. 

The dollar has met many of the technical objectives, and has overshot them against sterling, which has fallen for six consecutive sessions, the yen, and the Canadian dollar. While a deeper correction may ensue, we suspect that a clear picture will emerge in the coming days. The US reports CPI (likely to have accelerated) on Tuesday, the producer prices and Fed's Beige Book are out Wednesday, and import prices released on Thursday (expected to have risen). Also, by that time, the US will announce other bilateral tariff rates, especially but not only with the EU. After reporting an unexpected contraction in May (-0.1% after -0.3% in April), the UK is expected to report stubborn inflation and a continued streak of falling payrolls. Such a mix of data only exacerbates the coming fiscal challenges facing the government. Meanwhile, the market may see a robust eurozone industrial production report and continue to downgrade the chances of another rate cut this year. It finished last week at the least since early April. Lastly, of note, and its importance does not lie in its impact on the heavily managed yuan, but China will be the first large country to report Q2 GDP. Many expect China to acknowledge some slowing in activity. 

US

Drivers: It has become part of the mainstream narrative that the dollar has become decoupled from interest rates. While recognizing that the uncertainty emanating from Washington may mean that the dollar requires a greater interest rate to support it, the dollar's upside correction has coincided with US rates. The two- and 10-year yields are up about 17 bp this month. The implied year-end effective Fed funds rate rose by around 16 bp. Federal Reserve Chair Powell has been most explicit: If it were not for the tariffs, the central bank would likely have resumed its easing. At the end of last week, President Trump indicated that rather than a 10% universal tariff, he is considering 15%-20% levies. 

Data:   The US high-frequency data is likely to show firm consumer price pressures even as the real economy looks to be softening, with industrial output falling for the fourth month in the first six, and the first back-to-back decline of the year. Retail sales may have stabilized in June after falling in April and May. Consumer prices are expected to have risen by about 0.3% at the headline and core levels, which given the base effect, will translate to a 2.7% year-over-year rate (up from 2.4% in May) headline rate and a 3.0% core rate (up from 2.8% previously). While some businesses are eating the tariffs through narrower profit margins, import prices, excluding oil, rose at an accelerating pace in Q2. And contrary to the popular narrative, foreign investors, through April, purchased more US stocks and bonds in 2025 than in 2024. 

Prices: The Dollar Index met the (50%) retracement objective, near 97.90 of its decline from June 23. The next retracement (6.18%) is around 98.25. The trendline connecting the March, April, May and June highs is by 98.15 on Monday and closer to 97.80 at the end of the week. If a larger correction is afoot, a small gap from the lower opening on June 24 (~98.25-98.35) may attract and the 98.50 area corresponds to the (38.2%) retracement of DXY's losses since the mid-May high that was slightly shy of 102.00. 

EMU

Drivers: The euro's recent downside correction coincided with a little more than a 20 bp widening of the US two-year premium over Germany. The move appears nearly complete, though it will be clearer after the US June CPI on Tuesday. Many look for the euro to continue to climb and the next big target is near $1.20. The swaps market sees little chance of an ECB hike later this month. The probability of a hike at the next meeting in September has fallen to below 40% from nearly 60% at the end of last week. The European Central Bank front-loaded rate cuts, and although the euro's appreciation may continue to dampen price pressures, the easing cycle seems to have paused. The odds of another cut this year have been shaved to about 80%, the lowest in two months. The US tariff letter will likely surprise no matter the details. 

Data: The eurozone sees May industrial production, trade, and construction figures. Germany reports the ZEW investor survey. The data are unlikely to change the general picture that the regional economy has nearly stagnated after it expanded by 0.6% in Q1. 

Prices: The euro overshot the (38.2%) retracement of its rally since June 23, found near $1.1685, but has stalled ahead of the (50%) retracement, seen around $1.1640. It has approached but not traded below the 20-day moving average (~$1.1665), and it has not closed below it since May 19. The five-day moving average looks poised to cross below the 20-day in the coming days, for the first time since May 23. A convincing break of the $1.1600 area signals a deeper correction that could extend another cent or more. 

PRC

Drivers: Beijing continues to have the yuan shadow the dollar. In a weak dollar environment, it means the yuan gains against the currencies of its other trading partners. This year, only the Hong Kong dollar and Indonesian rupiah and Indian rupee in the Asia Pacific region have been weaker than the yuan. The yuan has depreciated by about 10.8% against the euro and 5.0% against the yen. The PBOC has been gradually ratcheted down the dollar's daily reference rate. It was set at CNY7.1475 before the weekend, the lowest since last November. It was last set above CNY7.17 on June 23. 

Data:  Chinese economic activity looks like it moderated in June and in Q2. On July 15, China will become the first large economy to report Q2 GDP. On a quarterly basis, it seems to have slowed to about 1% from 1.2% in Q1. On a year-over-year basis, the growth may have ticked down to 5.2% from 5.4%. The property market shows little sign of stabilizing, let alone recovering. The PBOC appears to have walked back its pledge to cut rates and reserve requirements. 

Prices: The dollar peaked in the middle of last week near CNH7.1880. It finished the week at a four-day low around CNH7.1660. It retraced (61.8%) of the bounced from the year's low set July 1, which was near CNH7.15. On a break of CNH7.1650, support is seen slightly below CNH7.16. 

Japan

Drivers: The rolling 30-day correlation of change in the dollar-yen and the US 10-year yield has approached 0.68, the highest since February. Recall it bottomed slightly below 0.10 on May 2. The 60-day correlation is near a three-month high. Changes in the exchange rate are more correlated with the rise in US 10-year yields than the Japanese yields. In fact, the 30-day correlation of changes of Japanese long-term bond yields (30- and 40-years) is positive correlated changes in the dollar-yen exchange rate. 

Data: The June CPI may the media's attention, though Tokyo's CPI on June 27 contained the signal: price pressure moderated. Tokyo's headline rate eased to 3.1% from 3.4% and the core (excludes fresh food) fell to 3.1% from 3.6%. Excluding fresh food and energy, Tokyo's CPI slipped to 3.1% from 3.3%. The national figure looks to have slowed to around 3.2% from 3.5% and the measure may have fallen to 3.2%-3.3%. The swaps market is discounting practically no chance of a hike at this month's meeting. It has about 10 bp of tightening priced by the end of the year, the least in about two months. Separately, Japan may revise May industrial production. It was initially estimated to have risen by 0.5% after falling 1.1% in April. In Q1, it rose by an average slightly less than by 0.5% a month, The service sector is faring better. The tertiary activity index rose by 0.3% in April, and the services PMI (51.7 vs. 51.0) suggests further gains. Japan's June trade figures will also be reported. There is a powerful seasonal pattern. In the past 20 years, the balance has improved in all but one year in June. In May, Japan reported a deficit of almost JPY640 bln. In the first five months of the year, Japan recorded a trade deficit of about JPY2.37 trillion (~$15.9 bln) compared with a deficit of JPY3.59 trillion in the same year ago period. Lastly, note that Japan goes to the polls for an upper house election on July 20. A poor showing by the LDP could set the stage of a leadership challenge later this year, but the immediate market impact is unlikely to be significant. 

Prices: The dollar posted its highest settlement against the yen since May 13. The next target may be the June 23 high near JPY148.00. For about two months, the greenback has chopped between almost JPY142 and JPY148.00. The momentum indicators are constructive. Even without new coupon supply next week, the US Treasury yields look poised to rise in the coming days. The higher US universal tariff base may reinforce the sense of higher for longer, aided by a firmer CPI and the largest rise in US import prices since February. 

UK

Drivers: Unlike the dollar, the sterling has found little support from the rise in UK 10-year Gilt yields. The rolling 30-day correlation of changes has been inverted for most of this year, with early March through early April an exception to the rule. In fact, the 30-day inverse correlation reached near -0.45, the most in a year. It is also broadly true of the correlation with the two-year Gilt yield. Except for a brief period at the start of the year, and against from early March through early April, the rolling 30-day correlation has been inverse. It is around -0.40, a little off the most inverse (-0.46 on July 4) since last June. 

Data: Two of the most market-sensitive reports will be released in the coming days: prices and labor. Given the base effect (the 0.1% increase in June 2024 drops out of the 12-month comparison), the rise is on the upside May's 3.4% year-over-year rate. Partly owing to a hike in utility taxes, consumer prices rose at an annualized rate of 4.8% in the first five months of the year compared with a 2.9% pace in the Jan-May 2024 period. Meanwhile, the UK labor market is slowing, and some at the Bank of England attribute it, at least partly, to the payroll tax increase. Wage growth is slowing, trending down this year, and continues to outstrip the rise of the CPI basket. For three weeks now, the swaps market has discounted an 80% chance or better of a BOE rate cut next month.

 

Prices: The unexpected contraction in May's GDP sent sterling through the $1.3530 low it saw last Tuesday and Thursday, which marked the (61.8%) retracement of the rally from the June 23 low. Sterling has declined for six consecutive sessions. That matches the longest losing streak in two years. Nearby support is seen around $1.3460-70, and a break signal another cent decline. The momentum indicators are falling and, ahead of the weekend, the five-day moving average slipped below the 20-day moving average. 

Canada

Drivers: The changes in the USD-CAD exchange rate and US two-year yield are about 0.25 over the past 30 sessions. The correlation of change in the exchange rate and the Dollar Index peaked near 0.80 in May and held above 0.70 until July 4 and is now near 0.65. The 30-day correlation with changes in WTI moves around quite a bit. It has been around -0.40 to 0.30 for the past two months and is now a little below 0.20. 

Data:  Like, the US, UK, and Japan, Canada also reports its CPI in the coming days. Barring, a dramatic downside surprise, the Bank of Canada most likely will not change monetary policy the month's end meeting (July 30). Still, May's 0.6 jump in the CPI overstates the case. A 0.1%-0.2% rise is likely in June. However, due to the 0.1% decline in June 2024, the year-over-year pace may quicken to 1.9%-2.0% after holding 1.7% for the previous two months. The underlying core rates have been firm at 3.0%-3.1% for the last two months, up from 2.5% at the end of last year. And like the US, Canada will report May's portfolio flows. In the first four months of 2024, foreign investors bought a net of about C$$64.4 bln of Canadian securities. In Jan-April 2025, they have been net sellers of about C$15.1 bln. Still, there are other sources of supply and demand for the currency than foreign purchases of stocks and bonds. And for the record, the Canadian dollar weakened in the first four months of 2024 (~-3.9%) while it appreciated (~4.0%) in the Jan-April 2025. 

Prices: The greenback looked at is if it might hold the (61.8%) retracement of its losses from June 23, found slightly above CAD1.3700. But the US 35% tariff lifted the US dollar to CAD1.3730, a two-week high. The details, including the treatment of products that are compliant with the USMCA that was negotiated in President Trump's first term. A push above CAD1.3740 could signal a return to CAD1.38. The US tariff and the sectoral tariffs can be expected to weaken the Canadian economy, but the year-end rate implied by the options market rose five basis points last week to 2.50%, the highest weekly close since late February.

Australia

Drivers: The Reserve Bank of Australia surprised the market with its decision to stand pat last week. The Australian dollar rallied but the rolling 30-day correlation of changes in the exchange rate and Australia's three-year yield is below 0.10. Its correlation with changes in the Canadian dollar is more than 0.65. The 30-day correlation of changes in the exchange rate and Dollar Index is around -0.65. It reached -0.80 in early July, its most inverse reading since April 2024. 

Data:  Following on the heels of last week's central bank decision, Australia will report on last month's labor market. Overall, Australia has created an average of 18.3k jobs a month in the first five months of this year compared with a 32.1k average in the same year ago period. However, full-time hiring has held up better. Of those jobs, 20.4k average per month, have been full time positions. In Jan-May 2024, full-time positions grew at an average pace of 24.5k a month. The challenge is that the participation rate continues to expand. It averaged 66.6% in the first five months of 2024 and 67.0% in the first five months of this year. Still, the unemployment rate has been steady at 4.1% this year. The futures market has a cut next month nearly fully discounted despite last week's surprise. 

Prices: The Australian dollar began last week poorly. On Monday, it settled below $0.6500 for the first time in almost two weeks. But, fueled by the central bank catching the market wrongfooted, the Australian dollar made a marginal new high for the year (~$0.6595) ahead of the weekend. The five- and 20-day moving averages, which had looked set to cross, are both rising. If it is an upside break, there is little chart resistance ahead of $0.6700. That said, a word of caution may be coming from the momentum indicators, which appear soft. 

Mexico

Drivers: The peso does not appear particularly sensitive to changes in US or Mexican rates. The 30-day correlation between changes in the USD-MXN exchange rate and the Dollar Index is around 0.50. It peaked a little above 0.65 in near mid-June, its best level since March 2024. The wide interest rate differential and relative low volatility make the peso an attractive long in carry trades against the dollar. In the first half, it generated a total return of almost 14.2% for US dollar investors. Mexican stock and dollar-bonds have outperformed the US this year. 

Data:  Mexico's economic calendar is sparse this week. The Labor Ministry is expected to report June nominal wages. In May, public sector employees’ nominal wage growth of 4.1% is nearly flat when adjusted for CPI. Private sector employees, on the other hand, have seen an 8.6% increase in nominal wages. After four half-point rate cuts, the central bank is expected to stand pat when it meets next on August 7. 

Prices: The dollar's gentle decline was extended to almost MXN18.55 last week. It has not been there since last August. The dollar appears to have put in a near-term base. The 35% tariff the US has levied on Canada spooks some market participants and the peso's loss of more than 0.5% before the weekend was largest decline in three weeks. For the past three months, the US dollar bounces to the 20-day moving average, now a little above MXN18.83, have offered peso buyers good opportunities. Some  particularly deft participants can monetize current hedges and reset on the dollar bounce. 

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