As I have previously suggested, the dollar seemed fundamentally undervalued and at the end of last week there was a correction after what could be called a ridiculous sell-off. Powell’s soft position and the lull on the tariff front only temporarily helped keep the focus on domestic factors of other major currencies, but on Friday the attention was drawn to the dollar again. The most likely reason for this is the looming deadline of the new Trump tariffs, a powerful source of inflationary pressure, which the Fed will likely need to curb by raising rates. Other world banks continue to lag behind in terms of tightening policies and consensus grows that best risk/yield ratio among major currencies is currently offered by the dollar.
On Friday, risk aversion spiked and capital poured into the dollar after Trump announced that he was ready for a deal with Mexico, pointing out that it was not possible to get around sharp angles in negotiations with Canada.
On Saturday, the US president said that NAFTA will be quite viable in the form of a bilateral deal, hinting that the “easy” end of negotiations with Canada was unexpectedly difficult. Attempts by Congress to ease Washington’s hard stance failed, because Trump threatened to break the treaty altogether. Nevertheless, the main threat to world trade comes from the tariffs of the US and China, which can reach a new level already on Thursday. Trump said he was ready to impose duties on Chinese goods worth $ 200 billion after the end of the discussion period.
The data on inflation in the Eurozone pointed to the growing gap in the need to raise rates between the ECB and the Fed. The basic indicator excluding goods with volatile prices rose by only 1% in August, almost half the target value of the ECB. Employment in the region for July lacked hints about higher inflation, remaining at 8.2%. Let me remind you that a decrease in unemployment often means a shortage of workers and accompanying inflation of wages, which is then transferred through spending to consumer inflation.
At the same time, data on consumer optimism from the University of Michigan, the Chicago PMI beat the forecasts without giving a reason to quibble to the impeccable growth of the American economy. Inflationary expectations for the year ahead were revised upward, from 2.9% to 3.0%, another signal in favor of consumer spending growth.
The report on activity in the manufacturing sector of Japan as a whole indicated stagnation in the sector, but it is interesting to analyze the reasons for this. The sector is mainly aimed at export, so Japan’s economic data on the manufacturing sector reflects the trend of protectionism in global trade. The data showed that export orders decreased, mainly due to the decrease in orders from China, one of the main partners in Japan. On the other hand, pressure on producers exerts an increase in cost inflation. In addition to energy costs, it is also the US steel tariffs, which through the supply chains also affect manufacturers. In this light, the Bank of Japan will have to support the sector through a weak yen, which reduces the chances of shifts in politics or even a change of rhetoric to meetings before the end of the year.
The pound made a failed attempt to trade optimism on Brexit, after reports from the EU’s chief negotiator about the “unprecedented” proposal for a deal with Britain. However, May continues to promote its “Chequers plan”, which is considered unsatisfactory by the EU. The glimmer of hope turned back into gloom after EU Barnier stated that he was against May’s proposal. Informal deadline for negotiations will be shifted from October to mid-November.
Emerging market currencies are prone to further decline, although losses on Monday were moderate. Their slump against the dollar is likely to continue because of new tariffs. The payrolls report for August represents a benchmark for the dollar this week and data for July allows us to form rather positive expectations about the US currency. The short-term goal for DXY – level 95.50 four days before the report, the strengthening of the dollar on Friday indicates that the main preparation for growth has already been carried out.
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