US dollar remains strong despite weakening economic data

Fed hawkishness and global uncertainty support US dollar

by Faruk Imamovic
US dollar remains strong despite weakening economic data
© Getty Images/Joe Raedle

Although US activity data has generally disappointed in recent weeks, the USD has stayed strong because:

  • 1. The Fed's rhetoric has been hawkish
  • 2. Political uncertainty outside the US has propped the USD
  • 3. Data outside the US has weakened too (e.g., Euro area PMIs)

Until these trends "switch" the USD may stay sturdy.

Key Points

  • - Mexico's central bank won't cut the policy rate today, and may even signal displeasure with the recent volatility in USD/MXN. A hawkish tone from Banxico - aligned with the prospect that the policy rate stays high indefinitely - may help steady USD/MXN, and foster a gradual decline back to 17.50.
  • - Responsible fiscal management in Brazil is taking a back seat to politics again, which is why the BRL weakened further yesterday. We remain bearish on the BRL, and find ourselves raising the USD/BRL target (from 5.40 to 5.50, recently) with every "faux pas" coming from the administration.

Following a session recently in which the USD did especially well against its peers, the USD's positive momentum has failed to hold this morning, and the EUR, JPY, GBP, and AUD are all mildly stronger against the USD. In the case of the EUR/USD, it found a cushion yesterday around 1.066, perhaps as traders took note of the poorer US data yesterday (e.g., new home sales, for May), and so EUR/USD has risen above 1.07 as we write.

Traders may be worrying a bit less about the budget policies of the National Rally (RN) in France, following that party's attempts to placate those worries with a public appeal (see here). Its leader, Jordan Bardella, has said that the European Commission's 3% deficit rule is "an objective", although he fell short of promising that it will be met. The RN's agenda, however, could contravene the EU's rules in many other ways, e.g., about VAT tax rates, integration into the common electricity, and through a 'nationalist' procurement policy for France's government. These are "Frexit-light" agenda items.

Also, with the USD/JPY up above 160, traders may be warier of FX intervention risks coming from Japan's MoF and BoJ over the next few days, and traders have stopped pushing the pair even higher. We continue to believe that USD/JPY intervention, if it comes, would occur during a low-liquidity period, such as the later hours of the trading session in New York on a Friday.

USD/CNY Analysis

As for USD/CNY, it bucked the trend overnight by continuing to rise, with the onshore spot level very close to the upper end of the allowed (+2%/-2%) band around the daily fix. PBoC will probably accommodate the USD's upside by raising the fix yet again, perhaps by a bit more than its recent 20-30 pips per day increments. That strategy, however, may encourage a one-way depreciation expectation eventually forcing persistent intervention to maintain the trading band. A band-widening is also a policy option, the risk for which could be underestimated by traders. As Trang notes (here), a band-widening would help get to a higher USD/CNY level faster if USD-buying pressure continues, a way to avoid a sudden devaluation if such a policy shift is called for in the aftermath of the US election - if plans to put massive tariffs on imports from China are realized in 2025.

USD Analysis
USD Analysis© Getty Images/Matt Cardy

Fed Rhetoric and US Data

By looking merely at the Fed's recent rhetoric, one would surmise that the US data flow has not yet made the Fed more "dovish" than it was at the June 12 FOMC meeting. Indeed, the Fed's reluctance to signal a rate cut more decisively has also been a propellant behind the strong USD, culminating with yesterday's USD rally. That push was helped by Fed Governor Michelle Bowman (here), who tempered market expectations for any interest rate cuts, based on "the risks and uncertainties" in her economic outlook.

And yet, one can't help but think that with the downbeat activity data that continues to emerge in the US since the April data cycle, some Fed officials would have incorporated more 'dovishness' into their narratives. Yesterday, it was the new home sales slump in May that caught traders' attention. But the softer US data began to emit with the slowdown in the growth of household employment in Q1, and has migrated stealthily to other labor-market data (weak job hires, weak job quits), and then to retail sales (two months of damp sales growth). Existing home sales haven't seen a bona fide rebound from the H2 2023 levels to begin with. Moreover, if it hadn't been for the big pop in the May services PMI (after the April drop to below 50), we'd be talking about a broader slowdown in the US business survey indexes than just in manufacturing.

Economic Sentiment and Indicators

Of course, some analysts may say that this US softness in Q2 was already pre-figured in the sentiment surveys. The Univ. of Michigan index has been abysmal (although largely reflecting poor sentiment among Republicans, not Democrats), and the regional Fed surveys (Dallas, Richmond, etc.) have been sedate too, although that's been for a longer time. The Conference Board's leading index has been in decline since mid-2022, led by the downward spiral in new orders indexes, and especially consumer expectations of business conditions. Finally, in case the reader thinks that we are cherry-picking, look at the activity surprise index for the US - its at its lowest in almost two years, following the string of worse-than-consensus data since late April.

USD Outlook

In theory, the softening of the US data could help build a case for a weaker USD. But that will require that the Fed start its rate cutting cycle, or at least provide more visibility onto it. That's not happening yet, but it could find its impetus in lower PCE PI inflation reports over the next few months. But until that happens, there are few (if any at all) drivers for a weaker USD. After all, the political scene in Europe is fraught with no more serenity than in the US, and rest-of-the-world data remains in a funk too, which nullifies the impact of weaker US data as a relative construct for the FX market. The weaker PMIs in Europe (in June) and China (in May) attest to the negative turn that activity around the world has taken in recent weeks and months.

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