Is a USD recovery underway?
The desk posits that a USD recovery may be underway, driven by recent trade deal optimism and the Federal Reserve's hesitance to cut interest rates. Per the full note from MUFG EMEA, this sentiment has contributed to a notable uptick in the USD's value over the past week. The Fed's current stance, coupled with positive trade developments, suggests a potential shift in market dynamics that could favor the USD's strength moving forward. However, the sustainability of these gains remains in question as traders weigh the implications of ongoing economic data and geopolitical developments.
What the desk is arguing
MUFG's analysis posits that the USD may be on the verge of recovery, buoyed particularly by renewed optimism surrounding trade deals and the Fed's recent stance on interest rates. This suggests that market conditions could be aligning favorably enough for the USD to strengthen, presenting a compelling investment narrative.
Specifically, the desk points to a reluctance from the Fed to implement rate cuts as a key factor. This would typically lend support to the dollar, especially in contrast to other major currencies that may not enjoy similar central bank backing. The implicit argument here is that any weakening in the dollar stemming from external pressures could be overridden by stronger-than-expected economic fundamentals domestically.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01USD recovery hinges on trade optimism and Fed's interest rate stance.
- 02Potential sustainability of USD gains being closely monitored.
- 03Market analysts remain cautiously optimistic amid external uncertainties.
Market implications
A sustained recovery in the USD could shift market dynamics, potentially leading to a stronger dollar compared to other major currencies. If the Fed maintains its current rates longer, it could bolster investment flows towards the USD, influencing currency pairs involving the dollar significantly.
Risks to this view
Key risks include the possibility of a backlash in trade negotiations that could negatively impact market sentiment and USD strength. Additionally, should there be unexpected economic data releases signaling weakness, this could shift the Fed's stance and potentially lead to rate cuts, undermining the USD recovery narrative.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday 9th May 2025 and joining Lee to pose some questions on the financial market themes for the week ahead is Michael Owen, Head of Global Client Desk EMEA. The following podcast is intended for professional investors and eligible counterparties only and not for retail clients.
Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Good afternoon, Lee. Hi, Michael.
So it's been another busy week in the FX market. Certainly the dollar has rebounded over the past week. I know a lot of the markets looking at what's going on in Asia, specifically in Taiwan, but what is your take on this and what's been driving the FX market?
Yeah, like you said, Michael, when we started this week, we did see some further dollar weakness with the dollar really weakening the most against kind of Asian currencies with the Taiwan dollar surging higher by almost 9% against the U.S. dollar over a two day period, which was the biggest gain on record going back to the 1980s. So that kind of outsized, moved, clearly indicated that something has changed. And we do think that this potentially is the start of a regime shift for currency management in Taiwan, where it does look like the policymakers domestically have taken more of a kind of standoff approach and intervened less aggressively than they have done in the past to prevent the currency from strengthening.
This could be certainly encouraged by negotiations that are taking place with the U.S. now to reach some form of trade agreement to help lower the tariff rates. It has been speculated, obviously, as well, that any form of trade agreement with the U.S. could include some kind of agreement to try to restrict Taiwan's ability to keep intervening as aggressively as they have done. And that potential, like you say, could open the door for further upside for Taiwan dollar going forward.
And certainly if that similar kind of dynamic was copied across other Asian countries as well, it could encourage further strength in Asian currencies more broadly. Admittedly, obviously, we haven't seen any kind of official confirmation that there is going to be a change in FX management in Taiwan. So it does suggest a lot of that is kind of speculation at the moment.
And we wait to see what happens going forward. But we'd also argue as well that there is certainly potentially grounds fundamentally for Asian currencies to show some catch up strength against the dollar. So they have kind of underperformed at the start of this year alongside the dollar, while we've seen other major currencies strengthening more sharply against the dollar.
So part of this move maybe is some kind of catch up strength for Asian currencies, but there is the potential there for some change as well in terms of how they manage FX intervention going forward. Outside, though, of those Asian currencies, like you were saying, Michael, we did see a little bit of kind of dollar weakness coming through and spilling over into currencies in the G10 space, which are more linked to Asian currencies like the Aussie, Kiwi and the Yen, all strengthened at the start of this week, but that those gains didn't prove sustainable. And then we've seen them kind of giving back those gains in recent days as the dollar has kind of rebounded more broadly against other G10 currencies.
Part of this is down to building optimism over trade deals that the U.S. can agree going forward to help reduce some of the tariff rates that have been put in place. We did see over the last day the U.K. reaching the first trade agreement with the U.S. and there's been building speculation as well that trade talks at the end of this week between the U.S. and China could see tariff rates reduced as early as next week. So that's helping to restore some more confidence in the global outlook and at the same time in U.S. policymaking, which is helping the dollar to rebound.
And then on top of that as well, we also had the Fed policy meeting this week where the Fed were very, very strongly kind of pushing back against expectations that they would look to cut rates kind of preemptively in response to the tariff shock. I think the message from the Fed for now is still that they're very much in data dependent mode and that for them to cut rates while inflation is going to pick up due to the tariffs, they need to see clear evidence that the labor market is weakening and that would then provide them the kind of green light to start cutting rates. And at the moment, that isn't the case, as we saw in the latest payroll reports.
The employment market is still holding up better than maybe people had initially expected. And we only have one more payrolls report before the next FOMC meeting in June. So it does look a bit of a long, long call for them to cut rates as soon as June.
So for us, we think at the moment, July is probably the earliest point that they could cut rates. So a more kind of delayed start to the Fed's rate cut cycle is also helping to offer some more support for the dollar at these weaker levels. Yeah, thanks very much, Lee.
And then a bit closer to home for both of us, but the UK this week, Bank of England in line, I guess, with a 25 basis point cut, but probably more interesting on those who didn't vote for a 25 basis point cut and why. But what's your take on the Bank of England and what we have in store? Yeah, I think the message from the Bank of England, I guess, is consistent with a high level of uncertainty over the outlook right now.
The Bank of England, like all central banks, is really kind of waiting to see in terms of what the impact is of all this trade policy uncertainty, trade disruption in terms of the impact on growth and inflation in the UK. I think the Bank of England definitely looks like it's more confident it's going to have a negative impact on growth in the UK, but their kind of assessment of what happens to the inflation outlook is a bit more nuanced. I think on balance, they do think potentially it could be more disinflationary.
Obviously, the fact that the UK is holding off from retaliatory tariffs and has agreed now this initial trade agreement with the US, that should help to ease upside risks to inflation in the UK from trade disruption. And if growth does slow more going forward because of the uncertainty and global growth slowing down, then I think the Bank of England would become more open to speeding up the pace of rate cuts later this year. But I think for now, like the Fed, they don't have kind of conclusive evidence either way to give them the confidence to speed up rate cuts right now.
So for that reason, I think the Bank of England is comfortable enough to keep to the current pace of quarterly rate cuts. So the idea of a kind of back to back rate cuts at the next meeting in June, I think that's certainly a lot less likely now with the August meeting, probably is the most likely for the next Bank of England rate cut. But the pound, I don't think that's like a big game changer.
Like it did help to support the pound a bit after the market moved to price out rate cut from the Bank of England at the June meeting. I think the bigger probably story for the pound really, which is helping it to kind of recover some lost ground really in recent weeks is this kind of recovery that we've seen in risk sentiment more broadly as investors are becoming kind of more optimistic over the prospect of trade deals to help reduce these tariff rates. Like you could certainly question whether that's going to be a kind of sustainable rebound in risk sentiment if tariff rates still remain at high levels, it's still going to be disruptive for the trade and global growth, which could lead to a setback for this rally in risk assets.
But for now, at least this trend is helping those kind of more high beta G10 currencies, the high yielding currencies like the pound to recover. And like you say, with one of those trade deals being with the UK, that has helped obviously sentiment towards the pound. But I suppose the details of that trade deal, obviously, there are some positive aspects in that the US has agreed to lower the tariff rates on some of the sectorial parts like autos and steel and aluminium down to lower levels.
But kind of offsetting that is still the US's insistence in maintaining this 10% universal tariff rate. So it's not like we're going back to the levels that were in place prior to Trump's second term. There's still going to be more trade friction there between the UK and US.
And I think the Bank of England would also kind of emphasise the downside risks that if Europe slows more due to tariffs and the rest of the world slows, then it's going to be difficult for the UK to avoid the negative fallout from that. Thank you very much, Lee, and wishing everyone a good week ahead. Thank you for listening to this MUFG Global Markets podcast.
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