FX Daily: Turning a blind eye to Fed independence risk

The dollar has weakened a bit further, in line with the direction set by lower front-end USD rates. Meanwhile, Fed Governor Lisa Cook has sued President Trump, claiming that an "unsubstantiated allegation related to a private mortgage application" is not sufficient “cause” to fire her. There is still plenty of uncertainty about the timing of any court ruling and whether Cook will remain in office. The two-year USD swap rate has been repriced only 5bp lower since Cook was fired, and pressure on long-end Treasuries has eased – signalling a rather sanguine approach.

While markets remain reluctant to speculate on this Fed story and continue to focus on data-driven short-term developments, the downside risks for the dollar have undoubtedly grown. If Cook leaves, her replacement could tip the balance, giving dovish governors a 4-to-3 majority - especially when factoring in Christopher Waller, Michelle Bowman, and the expected replacement for Stephen Miran (who could also become Fed Chair), assuming Jerome Powell stays on the board beyond May. Since governors must approve the appointment of regional Fed Presidents, who make up the remaining five FOMC votes, the risks of a long-lasting dovish shift would be considerably higher.

For today, expect great focus on US core PCE figures for July - remember that is the Fed’s favourite measure of inflation. We expect a 0.3% month-on-month print, in line with consensus. A slightly higher print could prompt a modest positive dollar reaction, but the bar for a rethink of the strong call for a September cut is high following Powell’s dovish remarks at Jackson Hole.

We think DXY can keep hovering around its 50-day moving average of 98.0 for now, although risks remain tilted to the downside.

Francesco Pesole

The European Central Bank's July minutes showed the Governing Council isn’t as concerned about the euro’s strength as some had speculated, but multiple members did point to downside risks to inflation and that, in our view, still suggests market pricing for year-end (-10bp) is too hawkish.

Anyway, given the silence of ECB doves of late and President Christine Lagarde reiterating that the ECB is in a good place with its current 2% rate, a dovish repricing doesn’t seem to be a particularly imminent story.

Today, we’ll see the first prints of the eurozone's August inflation, with France, Spain, Italy and Germany releasing numbers. Expectations are for broadly unchanged year-on-year figures from July, resulting in a modestly higher eurozone-wide headline reading and a modestly lower core print (released on Tuesday). The ECB’s inflation expectations for July are also published this morning.

All in all, we don’t think there will be much in the data to convince markets to materially reprice ECB rate expectations just yet. The French political earthquake is being endogenised and we don’t think it will hurt the euro much unless snap elections become the baseline scenario. EUR/USD remains cheap according to our short-term fair value model and we still favour a break above 1.170 in the next few days.

Francesco Pesole

With the exception of the New Zealand dollar (which was hit by a dovish cut from the Reserve Bank), the Canadian dollar has been the worst-performing G10 currency in August. We remain bearish on CAD against the euro and European currencies, as well as other commodity currencies, as Canada’s deteriorating economic outlook points to more room for Bank of Canada cuts.

Yesterday, it was reported that Canada’s 2Q current account deficit was the largest on record due to a drop in exports to the US. That increases the risk of a sub-consensus 2Q GDP print today: expectations are for a 0.7% annualised quarterly contraction.

Markets are only pricing in a BoC rate cut in December, but we suspect there are high chances of a September or October move and another cut in 2026 before reaching a 2.25% terminal rate. Given our bearish USD call, we don’t expect much support for USD/CAD, but we still expect the loonie to lag other G10 currencies.

Francesco Pesole

Poland is taking centre stage in the CEE region this week and next. Yesterday, the Minister of Finance presented the state budget for next year, when public finances are expected to reach a deficit of 6.5% of GDP. At the same time, this year's deficit was revised from 6.3% to 6.9% of GDP. Although the state budget deficit will be lower year-over-year, net borrowing needs will be higher than this year, which also suggests higher bond issuance. We highlighted this risk yesterday, and the market quickly responded with a sell-off, most visible in the bond market. Although FX avoided significant pressure, we can see some consequences today.

Today, August inflation figures will be released in Poland, where we expect a decline from 3.1% to 2.9%, in line with market expectations. The budget and inflation should be key topics for discussion at the National Bank of Poland meeting next week. Although fiscal policy is not such a problem that it would jeopardise the September rate cut, it will certainly play a role for the rest of the year. Two MPC members in recent days have mentioned that September may be the last cut this year, and one of the reasons is the excessive deficit. However, the market still expects at least two rate cuts this year and more next year. Therefore, we see any weakness in the zloty today as an opportunity for new long positions ahead of next week's central bank meeting.

In the Czech Republic, the second GDP estimate for 2Q will be released today. Our baseline expectation is confirmation of the flash estimate of 2.4% YoY, but we see some chance of an upward revision based on weaker-than-expected growth and strong monthly figures. The Czech National Bank expected 2.7% in its August forecast. Any narrowing of the deviation would only support a hawkish stance here. Still, we believe this is just one piece of the puzzle in the hawkish picture. Another is wage negotiations, where talks between the government and unions have been postponed until Wednesday next week. However, it seems that in any case, the increase in public sector wages should exceed the CNB's forecast. Overall, we remain bullish on the CZK, and EUR/CZK should return below 24.500.

Frantisek Taborsky