Larger tariff reductions to provide positive backdrop for the dollar for now

USD: US-China set to ease tariffs helping US dollar

We were not surprised by the scale of the FX moves yesterday following the details of the deal agreed between the US and China following talks in Geneva. Given President Trump had referenced 80% as a level and there was speculation that a level of 60% could be the level given that was the level President Trump cited in election campaigning last year, the reduction of the reciprocal rate to the 10% baseline was a big surprise. On a DXY basis the dollar fell 9% from the beginning of March when tariffs on China were raised for the second time through to the low-point in April following the reciprocal tariff announcements on 2^nd April. The dollar has now rebounded 3.5%, which, given the drop since the start of March, we believe indicates the scope for further gains following the massive tariff shift announced yesterday. The de-escalation could also have implications for Fed policy. Fed Chair Powell was clear at the press conference following last week’s meeting that it would be difficult to change the monetary stance given the elevated level of trade uncertainty. This 90-day postponement of the reciprocal tariff rate for China (34%), that could feasibly trigger another round of retaliatory tariff hikes, expires in August just following the FOMC meeting at the end of July. So this announcement makes a July rate cut less likely, pushing back further the potential timing of a cut. A week ago the market was fully priced for a 25bp cut in July, and that pricing has dropped to just 10bps now. Economic activity is certainly likely to get a boost over the short-term as companies potentially push to get orders through over the coming 90-day period. China today announced it was ending the ban on Chinese airlines taking delivery of Boeing plans. The Nasdaq Composite surged 4.4% yesterday reflecting an easing of recession fears.

Still, according to Trump this deal is going to result in a “complete opening” of China’s economy. That would see US imports grow relative to China exports, closing China’s trade surplus and narrowing the US trade deficit. This has been the recommendation for China (and Germany) for decades and it hasn’t happened so there remains risks that Trump doesn’t get what he thinks he got and we have tariff rates back higher. So there is a high risk that tariffs move higher from what is now still very high tariff levels historically – 30% on all imports and sector-specific tariffs and tariffs from Trump 1.0 and the Biden presidency.

So further dollar gains is certainly feasible from here but there will be limits given we should begin to see the damage done in the data over the coming months. The labour market data (other than NFP) certainly indicate a marked weakening is coming.

USD REBOUNDS WITH US YIELDS

Source: Bloomberg, Macrobond & MUFG GMR

GBP: Very close call for MPC last week

The market moves have been very much driven by the sharp reduction in tariff rates that fuelled renewed optimism that President Trump’s tariff policies may not be as damaging to the US economy. The close association of Canada to the US and the jump in crude oil prices helped CAD and NOK to top the G10 performance table yesterday after the US dollar. Next best performing was the pound in part perhaps following the UK having reached a deal with the US and leaving the pound better placed to respond to changing developments in the global trade outlook. Yesterday, the BoE also held its annual BoE Watchers Conference in London which meant we had a host of MPC speakers – Deputy Governor Clare Lombardelli, along with MPC members Megan Greene, Catherine Mann, and Alan Taylor.

In the context of what happened yesterday – the sharp reduction of US-China tariffs – the comments from Megan Greene and Clare Lomardelli were notable. Both yesterday stated that their decisions to vote to cut the key policy rate last week was finely balanced and leaned in favour of a rate cut given the elevated level of uncertainty related to global trade. Since the MPC meeting, we have had the UK-US deal announced (although the MPC would have been aware of that) later that day but then more importantly the dramatic de-escalation of US-China tensions. It seems quite likely that if the MPC meeting had been a week later both would have voted to leave the key policy rate unchanged.

Megan Greene’s comments that she was close to not voting for a cut last week is less surprising. Greene has voted against the majority on four occasions since joining the MPC in August 2023 and each of those dissents were on the hawkish side. Clare Lombardelli is a newer MPC member and has only attended seven MPC meetings so far but has always voted with the majority. The fact that Lombardelli’s vote was finely balanced is therefore the more telling. She justified her cut as an “insurance” against economic slowdown due to the global trade conflict which could imply now that she will not be in a rush to cut again. Like Greene, Lombardelli’s concerns centre around the labour market and domestically-generated inflation pressures. Wage growth remains too high and is not consistent with the BoE’s 2.0% inflation target.

This morning, the ONS released the monthly labour market data and overall the data is on the softer side but a little mixed in terms of wage data. The headline wage growth rate on a 3mth YoY basis was stronger than expected but excluding bonuses was a little weaker. The PAYE jobs data continues to show a notable slowdown and a clear weakening trend. The employment change m/m was -33k in April after a 47k drop (revised from -78k) and the April drop was the fifth in the last six months and seventh in the last nine months. But the PAYE wage data was stronger than expected. It’s clear from this data that the UK labour market is weakening. Overall the labour market data looks consistent to us with the BoE easing policy but in a careful and gradual manner.

UK PAYE EMPLOYMENT DATA DIVERGING SHARPLY FROM UK LABOUR FORCE SURVEY DATA

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com