USD remains on a softer footing ahead of NFP report

USD: US trade & fiscal policy uncertainty in focus ahead of NFP report

The US dollar has continued to trade on a softer footing overnight after falling to fresh year to date lows at the end of last week. It has resulted in the dollar index falling back to within touching distance of the 97.000-level. The top performing G10 currencies overnight have been the yen and New Zealand dollar which have both strengthened by 0.5% against the US dollar. The renewed sell-off for the US dollar has coincided with a correction lower for US yields. The 2-year US Treasury yield has dropped from a peak of just over 4.0% earlier this month back towards 3.7% encouraged by dovish comments from Fed officials including Governors Waller and Bowman who indicated that they could consider restarting rate cuts as soon as next month. In light of those comments, market participants will be closely scrutinising the upcoming release of the latest nonfarm payrolls report on Thursday ahead of the 4^th July Independence Day holiday on Friday. The report would have to reveal a significant slowdown in employment in June and/or larger increase in the unemployment rate to prompt the Fed to cut rates as soon as next month given that the latest DOT plot from the June FOMC meeting revealed participants were very divided over the scale of easing they favour through the rest of this year. Employment growth so far this year has slowed an average of 124k/month and the unemployment rate has remained stable between 4.0% and 4.2% which has not been weak enough to trigger rate cuts so far this year while US policy uncertainty remains elevated.             

The Fed and market participants are expecting to have more clarity over US trade policy in the coming weeks. The 90-day delay for the higher “reciprocal tariffs” comes to an end on 9^th July. So far the US has only announced a trade deal with the UK but Trump administration officials have expressed optimism that deals with other countries will be announced ahead of the self-imposed deadline. In a Fox News interview yesterday, President Trump stated “I don’t think I’ll need to” when asked if he would extend the deadline but also added that “I could, no big deal”. His preference was to make it shorter. President Trump also threatened to impose a higher tariff on Canada this week in response their decision to implement a digital services tax which he called a “direct and blatant attack on our country”. It has prompted Canada to immediately withdraw the digital services tax to restart trade talks with the US. Prime Minister Carney and President Trump will try to reach a deal by 21^st June. US Treasury Secretary Scott Bessent also indicated that about 20 countries that don’t reach trade deals could continue negotiating but would see their tariff rates reverting to the higher “reciprocal rate” or stay at the current 10% if they are deemed to be “negotiating in good faith”. He noted that those would be mostly “smaller trading partners” dampening the negative economic impact.    

At the same time, the Trump administration is making progress in passing the One Big, Beautiful budget bill through Congress. The Senate worked through the weekend with votes scheduled for Monday morning. Market attention has been focusing more on the negative impact on the US government’s fiscal outlook from the budget bill rather than potential support for growth in the coming years which has been contributing to negative sentiment towards the US dollar. The CBO released an estimate over the week that the legislation would increase the deficit by nearly USD3.3 trillion. 

EVIDECNCE OF SOFTENING US LABOUR MARKET BUILDING UP

Source: Bloomberg, Macrobond & MUFG GMR

CAD: Canada drops digital services tax in response to Trump pressure

The CAD has strengthened after Canada’s decision to withdraw the digital services tax which opened the door to restarting trade talks. USD/CAD briefly hit a high of 1.3759 on Friday after President Trump announced he was cutting off trade talks with Canada “immediately” but has since dropped back towards 1.3650 overnight fully reversing the move higher from late on Friday. The statement released by Canada also added that Prime Minister Carney and President Trump have agreed that parties will resume trade negotiations with a view towards agreeing on a deal by 21^st July. Potential disruption for Canada from the looming higher “reciprocal tariffs” should be more limited given the current lower tariff rate of 10% should remain the same even if a deal is not reached and/or the deadline extended. Overall, it suggests that risks are more tilted to the upside for Canada’s economy and the CAD from ongoing trade negotiations as it is more likely tariffs will be lowered rather than raised further.

The implications for the BoC’s policy decision in July from a trade deal would be less clear cut. On the one hand a trade deal would help to ease downside risks to growth going forward but on the other hand it would ease upside risks to inflation in the near-term. The BoC could take advantage of less inflation risk to deliver further easing to provide more support for growth. The BoC is likely to have more clarity over trade policy at the 30^th July policy meeting. Like the Fed, the BoC is expected to leave rates on hold in the near-term until it has evidence to dampen concerns over upside risks to inflation from tariffs. The Canadian rate market is currently pricing in around 11 bps of BoC rate cuts by 30^th July policy meeting. The release last week of the latest Canadian CPI report for May provided some relief revealing that core inflation measures eased back to 3.0% after picking up from around 2.5% at the start of this year. A further loosening of labour market conditions in this week’s Canadian employment report would support further policy easing as well. The unemployment rate hit a fresh cyclical high of 7.0% in May and has now risen by around 2 percentage points from the low point in 2022.

The sharp weakening of the USD this year has increased market attention on the risks of unhedged exposure to US asset holdings for foreign investors. Canadian investors are amongst the largest holders of US assets highlighting the deep financial integration between both countries. The latest update on Canada’s exposure to US assets was released earlier this month on 11^th June.  The value of US equity & investment fund shares held by Canadians has increased to CAD2.23 trillion in Q1 2025 up from CAD1.08 trillion in Q4 2019. It equates to around 72% of GDP in Q1 2025 compared to around 47% of GDP in Q4 2019. The potential for increased hedging flows to mitigate for the risk of the USD weakening further could continue to weigh down on USD/CAD which has already returned back to the mid-1.3000’s where it was trading between Q4 2022 and Q3 2024.  Please see our latest FX Weekly for more details (click here).            

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com