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Despite two dissenting votes, the Fed delivered a broadly hawkish hold, with Chair Powell remaining firm on his inflation call and forcing markets to trim September cut bets. The US dollar’s rally may have a bit more to run as today’s core PCE figures may come in above consensus and tomorrow’s jobs figures prove good enough to endorse the Fed’s prolonged pause
USD: Dollar Rally Can Go a Bit Further
The dollar continued to appreciate in line with our call, as GDP data came in stronger than expected and the Fed gave no hints of bending to Trump’s pressure.
While the FOMC acknowledged the economy is slowing and two members – Bowman and Waller – voted (as expected) for a cut, Chair Powell’s press conference was hawkish. He reiterated expectations for a short-lived inflationary impact and said a modestly restrictive policy was appropriate.
He seemed to put himself on a collision course with President Trump by claiming the Fed was looking through inflation by not hiking. The result has been a selloff in front-end Treasuries, with market pricing for September falling from 16bp to 11bp. The dollar extended its rally.
Whilst tempting, we are not calling for the end of this dollar run just yet, primarily because today’s core PCE and tomorrow’s jobs figures (Powell stressed the importance of the unemployment rate yesterday) can lead to even further hawkish repricing in the USD curve, keeping the dollar bid.
Based on the core PCE deflator QoQ annualised rate of 2.54% in yesterday’s GDP report, assuming no change to the history (0.14% MoM in April and 0.18% MoM in May), today’s June core PCE deflator should be 0.46%MoM, well above the 0.3% MoM consensus forecast. There is a tangible risk that revisions still result in a 0.3% MoM print today, but risks are clearly on the upside.
Another data point worth noting is jobless claims, which has recently caught our attention after an unexpected six-week streak of declines. That’s the longest run since August-September 2022, and may be contributing to expectations of a resilient labour market.
Elsewhere, the Bank of Japan held its policy rate steady at 0.5%, but surprised markets by sharply raising its inflation forecast for FY2025 to 2.7%, up from 2.2%. This hawkish tilt signals growing confidence in sustained price pressures, especially from food costs, and hints at a potential rate hike on the horizon. However, policymakers also flagged concerns about a possible economic slowdown, suggesting any tightening will remain cautious and data-dependent.
EUR: Staying Fragile
Eurozone second-quarter growth was marginally better than expected, but at 0.1% QoQ it still proved unsupportive for the euro, even when accounting for the tariff distortions. If the first leg of the EUR/USD correction was driven by the grim growth prospects for the eurozone after the EU-US trade deal, the drop to 1.14 was led by the Fed’s hawkish repricing. In our view, risks remain on the downside for EUR/USD, even though positioning is now looking considerably less stretched after the squeeze of dollar shorts since the start of the week.
We don’t think the eurozone data will help the euro much. Flash inflation estimates for July will be published this morning in France, Germany, and Italy, and there seems to be limited scope for any upside surprise. Markets rushed to price out an ECB cut (only 15bp priced in by year-end) after last week’s central bank meeting, but low inflation paired with soft growth expectations can lead to a dovish rethink.
Some comments by ECB members could accelerate that process, but August is generally a rather quiet period for ECB speeches.
We think an extension of the EUR/USD drop to 1.130 remains possible – that level acted as a temporary anchor in parts of April and May. Our view is that by the end of September, we’ll be back at 1.150, but there may well be more downside exploration before then.
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