The US dollar is trading with a modestly weaker bias after fresh evidence that price pressures are moderating in the world’s largest economy reinforced expectations that the Federal Reserve could begin cutting interest rates as early as October.
Underlying inflation eased by more than expected last month. Data released by the Bureau of Labor Statistics this morning showed core consumer prices, which exclude food and energy, climbing just 0.1 percent in May from a month earlier, slowing from the 0.2-percent pace recorded in April, and undershooting market expectations for a steady print. Core prices rose 2.8 percent on a year-over-year basis, down from 2.9 percent. The headline all-items consumer price index also rose just 0.1 percent relative to the prior month, and 2.4 percent over the same period last year. Services costs fell as demand slipped – particularly in airfares and other discretionary categories – and tangible goods prices continued their descent, with widely-feared tariff effects remaining conspicuously absent.
Rate cut expectations have been pulled forward. Futures markets are now assigning roughly 65 percent odds to a quarter-point cut at the Fed’s September meeting, up from 50 percent before the numbers were published, and the first move is fully priced in for October. Two-year Treasury yields, which are highly sensitive to interest-rate expectations, are down 5 basis points, and equity futures are pointing to a solid open on Wall Street.
The announcement of an agreement on a “framework to implement the Geneva consensus” in trade talks between the US and China was met with a collective shoulder shrug from markets last night. US Commerce Secretary Howard Lutnick said Beijing would work to increase cross-Pacific shipments of rare earth metals and Washington would remove some export restrictions in exchange. However, underlying tensions remain unresolved, with China remaining reluctant to significantly alter its investment-driven economic model — a key factor behind a bilateral trade surplus that has long surpassed, both in absolute terms and relative to US gross domestic product, the scale of the US-Japan trade imbalance at its peak in the late 1980s.
Stock markets have recovered losses suffered since President Trump’s April “Liberation Day” tariff announcement and are back near record highs, but the dollar is still down against the currencies of all major US trading partners this year. The administration’s economic policies and isolationist trading posture have forced a downgrade in long-term growth expectations, a rise in the risk premia attached to US assets, and a rotation in investment allocations toward other regions, particularly the euro area. In theory – if concerns about the “exorbitant burden” imposed by the dollar’s dominance are correct – this should contribute to a reduction in global trade and investment imbalances. In practice, the jury is still out.
Across the border, Canada’s plan to increase defence spending hasn’t materially shifted the loonie’s direction. New military commitments announced by newly-minted Prime Minister Mark Carney on Monday are expected to bring Canadian expenditures up to the NATO 2-percent target in short order. This increase could deliver positive spillover effects in the economy as funds flow to defence-sector firms, salaries increase, and research and development budgets grow. Canada should also see reduced vulnerability to charges – often levied by the Trump administration – that the country isn’t pulling its weight, bolstering its position going into the next round of trade negotiations. But without offsetting tax increases, Canada’s fiscal position may worsen in the years ahead, and major questions remain around just how fast the military will spend its newfound largesse. The impact on the currency market in the here and now is therefore relatively minimal.
