Rate cut calls in the face of economic resilience

USD: Calls for cuts make less sense now

The US dollar is marginally weaker today but remains over 2.0% stronger from the intra-day low recorded on 1^st July ahead of the payrolls report and then the batch of trade tariff letters that have been sent since 7^th July. The flow of economic data during this period of renewed escalation of trade tariff risks has certainly underlined the ongoing resilience of the US economy. The latest – the retail sales data for June –   confirmed that resilience with auto sales helping lift overall sales by 0.6%. The 1.2% increase in auto sales may still reflect consumption brought forward ahead of expected price increases related to tariffs – separate unit sales data suggests slowdown ahead. But even the Control Group sales was solid, up 0.5% m/m highlighting resilience in discretionary spending as well. The sales data followed a CPI report that certainly suggests goods inflation is accelerating and the tariff impact is beginning to emerge and there are risks of that extending further. Disinflation in services in keeping these gains in check – but the core goods CPI ex-autos gain of 0.55% m/m was the biggest since November 2021. The initial claims data yesterday also provided little evidence of any imminent deterioration in the jobs market.

The data certainly seems to back up the Fed for now in its caution over cutting rates. The resistance from the FOMC to cutting rates while backed up from this recent flow of data will not be helped by the explicit call for a rate cut from one of the senior FOMC members – Governor Waller. While FOMC members always express differing views, the call for a rate cut from Waller was much more explicit than is normal for a Governor. Admittedly on 20^th June Waller indicated his support for cutting rates “as early as July” but at the start of June spoke about the potential for a rate cut on good news “later in the year”. So his stance has hardened quickly and while Waller denies it is motivated by politics many will likely take that view. Governor Michelle Bowman on 23^rd June also indicated her potential support for a rate cut in July. Both Waller and Bowman were appointed to the Board of Governors by President Trump. Adriana Kugler’s term expires in January and Powell’s as Chair in May (although technically that doesn’t mean he leaves the Board of Governors, it remains likely). So four Governors by mid-2026 will be Trump picks.

So this threat to the Fed independence will not go away. Whether it’s via explicit attempts to fire Powell, or continuously undermine him through Congressional interference (Fed building renovations criticism continues to build) damage is being done to the independence and credibility of the Fed. The recovery of the dollar could feasibly extend further on momentum and positioning-related flows and after a 10% drop it is no surprise FX flows are more two-way. But the scope for any meaningful recovery of the dollar remains very limited in our view given these building efforts by the Trump administration to interfere and turn the Fed notably more dovish over time.

THREATS TO FED INDEPENDENCE WILL STEEPEN THE YIELD CURVE WHICH WOULD COINCIDE WITH USD DEPRECIATION

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Key few days for yen outlook

Today, US Treasury Secretary Scott Bessent is in Osaka today at the World Expo and met with Japan’s chief trade negotiator Ryosei Akazawa and there is speculation of a possible meeting with PM Ishiba in Tokyo as well. The lack of headlines indicating progress on trade negotiations suggest momentum has stalled with the negotiation strategy of the government being questioned. Japan have been taking a tough stance with an insistence of some give in relation to the 25% auto tariff and this stance is not yielding any results. Part of the government strategy is also likely reflects the difficult timing with the upper house election taking place on Sunday. Once the election is passed the government may then be in a position to give way on its tough stance without the risk of political damage being reflected by lost votes and a possible lost majority in the upper house.

The yen has been weakening over this week and last week on two factors – the 25% tariff confirmed in Trump’s letter to Japan last week and polling data that increasingly indicates the prospect of the government losing its majority in Sunday’s election. The government’s popularity continues to wane, in part due to the ongoing cost of living crisis. On Monday an NHK poll revealed PM Ishiba’s approval rating fell from 39% in June to 31% while support for the LDP fell from 31.6% in June to 24%. A Kyodo News poll conducted on Sunday and Monday indicated the LDP would win less than 40 seats while New Komeito is expected to win no more than 10 seats. The ruling coalition need to win 50 of the 125 seats being contested to maintain its majority.

A loss of the majority will put pressure on PM Ishiba to step down although it is believed now that PM Ishiba will resist that attempt to build support with other parties. With most other parties calling for further support for households, speculation of additional fiscal spending will likely see further rises in JGB yields and additional yen selling. A poor election result could also make doing a trade deal with the US more difficult ahead of the deadline on 1st August.

The yen is the second worst performing G10 currency since the start of last week, so a loss of majority is certainly partially priced but a lurch through the 150-level is likely if the government loses its majority. The exit polls are expected to be announced at 8pm local time in Japan on Sunday evening (12 noon BST). Monday is a vacation in Japan which could add to uncertainties with the JGB market closed. FX trading liquidity will therefore be less than normal which could exacerbate moves in early trading on Monday.

HIGHER SUPER-LONG JGB YIELDS NO LONGER SUPPORTING THE YEN

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com