FX Talking: Powell plays dollar defence

After an exceptional decline over the first half of the year, the dollar is starting to show some stability. That is partially on the view that the US labour market remains ‘solid’ and that the Fed does not need to rush into early rate cuts. Our baseline view over the next three months is that tariff-driven US price pressure starts to emerge and that the Fed will continue to resist political pressure to cut rates.

For EUR/USD that could mean a temporary correction to the 1.14/15 area – especially on our view that the ECB does take rates sub 2.00% in September. But by year-end, we would expect EUR/USD to be back near 1.18/1.20 once the Fed is ready to cut, seasonal dollar selling emerges and speculation over Jay Powell’s replacement as Fed Chair is at fever pitch. An independent Fed really is crucial for the dollar.

Though markets have learned to live with tariff uncertainty, fiscal risks linger. We have some concerns over fresh US Treasury issuance later this quarter, but those concerns extend to UK Gilts and more recently to Japan’s JGBs. On the latter, uncertainty around fiscal policy after the 20 July Upper House election could see USD/JPY briefly approach 150 - but not hold those levels for long. Fiscal risks look more of a problem for GBP. Elsewhere in G10, we think the Scandinavian currencies look a little undervalued.

In EM, the carry trade has proven a dominant theme and lifted large parts of Latin America, plus high-yield pockets such as in Hungary and Turkey. We do have increasing concerns about the forint but remain positive on the Czech koruna where the monetary easing cycle has finished in our view. In Asia, USD/CNY remains surprisingly calm and dependent on whether the US-China trade truce holds beyond August.