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EUR/CHF continued to gyrate in range below 0.9445 last week. Initial bias remains neutral this week first. Price actions from 0.9218 are seen as either a corrective move or the third leg of the pattern from 0.9204. On the upside, break of 0.9419 will resume the rise from 0.9218 through 0.9445 resistance. However, break of 0.9296 support will bring retest of 0.9218 low.

In the bigger picture, prior rejection by long-term falling channel resistance (now at 0.9548) retains medium term bearishness. That is, down trend from 1.2004 (2018 high) is still in progress. Firm break of 0.9204 (2024 low) will confirm resumption. This will remain the favored case as long as 0.9660 resistance holds.

In the long term picture, overall long term down trend is still in force in EUR/CHF. Outlook will continue to stay bearish as long as 55 M EMA (now at 0.9919) holds.

Monday, May 19, 2025

Tuesday, May 20, 2025

Wednesday, May 21, 2025

Thursday, May 22, 2025

Friday, May 23, 2025

Week in Review: Optimism Begins to Fade as Consumer Sentiment Deteriorates

Wall Street's main indexes were set to end the week on a high note, thanks to a temporary truce in the U.S.-China trade war. The S&P 500 was on track for its fifth straight daily gain, with all three major indexes showing weekly growth.

Stocks bounced back earlier in the week, with strong rallies on Monday and Tuesday after the U.S. and China agreed to pause their trade war for 90 days.

This pushed the S&P 500 back into positive territory for the year, the first time since late February. However, it’s still about 4% below its all-time high.

However, sentiment has suffered toward the backend of the week thanks in part to US data. Thursday's data was PPI, Retail Sales and the NFIB small business optimism index and these revealed some concerns which have weighed slightly on overall sentiment ahead of the weekend.

The biggest concern came from small businesses, who are getting more pessimistic about the economy.

The NFIB Small Business Optimism Index declined 1.6 points in April, to 95.8, its lowest since October 2024. 6 of the 10 index components decreased, with expected business conditions having the most negative contribution.Over the last 4 months, the index has fallen 9.3 points, the sharpest drop since the 2020 pandemic.

At the same time, the share of small firms expecting better business conditions 6 months from now has plummeted 37 percentage points, to 15%, the lowest since October 2024.

The mood remained sour after Friday's release of the University Of Michigan Consumer Sentiment Preliminary Data, which showed the index dropped sharply to 50.8 in May 2025, down from 52.2 in April and much lower than the expected 53.4, based on early estimates. This is the fifth monthly drop in a row, the lowest since June 2022, and the second-lowest ever recorded.

Rising inflation worries and concerns about tariffs are hurting confidence. Both the current conditions index (57.6 vs 59.8) and future expectations (46.5 vs 47.3) got worse. Personal finances took a big hit, falling nearly 10% due to weaker incomes. Nearly 75% of consumers mentioned tariffs as a concern, up from 60% in April, showing trade policy uncertainty is a major worry.

Inflation expectations for the next year jumped to 7.3%, the highest since 1981, up from 6.5%, while long-term inflation expectations also rose slightly to 4.6% from 4.4%.

Source: LSEG

The consumer sentiment data has definitely dampened the mood heading into the weekend. However, the mood remains optimistic for now but if data in the week and weeks ahead continue to deteriorate even trade deals may not be enough to lift optimism around a potential global slowdown.

The Week Ahead: Central Banks in Asia Pacific and UK Inflation on Deck

The week ahead has several important data releases lined up. The US gets a bit of a data break in the week ahead with Europe and the UK taking center stage. We will also have a busy week in the Asia Pacific region where the data dump for China begins

Asia Pacific Markets Outlook

The Reserve Bank of Australia (RBA) is expected to lower its cash rate by 0.25% to 3.85%. While April's inflation numbers were higher than expected, core inflation, which the RBA focuses on dropped to 2.9% year-on-year. This is the first time since 2021 that core inflation is within the RBA's target range.

China's April economic data kicks off on Monday. Retail sales are expected to grow to 6.3% from 5.9% last year, showing stronger domestic demand. Fixed-asset investment should stay steady, rising slightly to 4.3%. Industrial production may slow to 6.0% from 7.7%, as earlier PMI and trade data hinted at a mild slowdown. Property prices in 70 cities, also out Monday, will reveal if the market has hit bottom, with some cities stabilizing or seeing slight increases, though overall prices remain negative. On Tuesday, banks are likely to cut 1-year and 5-year loan rates by 0.10%, following a recent rate cut by the central bank.

Japan's data is expected to weaken, as US tariffs impact exports and manufacturing. Flash manufacturing PMI is likely to drop. Exports should grow by 2.5% in April compared to last year, but slower than March. Strong exports to Asia will help offset the drop in US exports. A big fall in imports should keep the trade surplus intact. Meanwhile, core inflation is expected to rise sharply in April, driven mainly by higher service prices.

Europe, US and UK Market Outlook

With 30-year mortgage rates stuck just below 7% and the average home loan at $450,000, monthly payments are nearly $3,000. This highlights how unaffordable the US housing market has become, leading to very low mortgage applications. Recent financial market volatility has made buyers even more hesitant, which explains why home builders are feeling so down. This is reflected in the sharp drop in the NAHB sentiment index in May. All of this suggests that sales of new and existing homes will remain very slow in the next batch of data.

In the Euro Area, the economy hasn’t shown major problems from the trade war. April’s manufacturing data was surprisingly strong, likely boosted by businesses rushing to act before US tariffs hit. May’s data will reveal if the sector can handle global challenges. I am not too optimistic but I do admit, I am a fan of surprises.

Consumer confidence will be key following the revelations from US consumer confidence data this past week. Consumer confidence has dropped a lot recently, meaning people are less likely to spend the extra money they’re earning from higher wages. However, if people start worrying less about the global economy, we might see stronger spending at home.

We also have the EU-UK summit which kicks off on Monday is mainly about agreeing on a defence partnership, but the UK also wants to make progress on economic issues. The UK is pushing for an agreement on food standards to reduce border checks. However, disagreements over migration and fishing are making it harder to improve economic ties.

April’s inflation data is important because many service prices go up annually during this time. In the past, this data has often been higher than expected. However, we think services inflation will be lower than the Bank of England’s 5% forecast. If we’re right, it might not lead to a rate cut in June, but it could make one more likely in August.

For all market-moving economic releases and events, see the MarketPulse Economic Calendar. (click to enlarge)

Chart of the Week - US Dollar Index (DXY)

This week's focus remains on the US Dollar Index.

The index has struggled to build on Mondays impressive gains following the US - China 90-day pause.

US data did little to assist the greenback this week as it toiled around resistance at 101.18 since Wednesday.

The index is on course to close the week with marginal gains and the trendline breakout still supports the idea of a move higher.

This is coupled with the period-14 RSI holding above the 50 neutral level which is a seen as a sign of bullish momentum still being in play.

The lack of data next week means the DXY may need another catalyst if the bulls are to take control. there has been rumors of potential trade deal announcements coming soon.

This could be the push the index needs right now for bulls to really make a serious push to the upside.

US Dollar Index (DXY) Daily Chart - May 16, 2025

Source: TradingView.Com (click to enlarge)

Key Levels to Consider:

Support

• 100.61
• 100.00
• 100.00

Resistance

• 101.18
• 102.16
• 102.64

Canadian Highlights

• The Federal government is foregoing its usual spring Budget, but is pushing forward with election promises. The Ontario government expects to run a deeper FY 2025/26 deficit as economic relief clashes with a softening revenue outlook.
• Canada’s housing market remained subdued in April as weak consumer confidence weighs on sales activity.
• Inflation updates for April next week will be a key marker for the Bank of Canada’s policy decision on June 4th. We expect a print on the softer side before tariff impacts start to embed in prices.

U.S. Highlights

• U.S.-China trade tensions were toned down this week, with both countries agreeing to a temporary truce that would see some tariffs on each other’s goods come down substantially.
• Following a strong showing in March, retail sales barely grew in April. The details hinted at consumer efforts to get ahead of potential tariff-related price hikes.
• Housing starts managed to eke out some modest growth in April, but the gain was entirely concentrated in the smaller and more volatile multifamily sector.

Canada – Budgets, And Lack Thereof

Canadian governments were in the spotlight this week amid a relatively light calendar for Canadian economic data. Volatility in Canadian financial markets also scaled back this week, mostly taking cues from developments south of the border. Canadian yields finished the week roughly flat, the TSX rallied by 1.5%, and the Loonie dipped three-tenths of a cent to 0.716 cents/USD.

On the federal government side, Prime Minister Mark Carney and his new cabinet hit the ground running, signing a symbolic order to prioritize their promised income tax cut by July 1st. This measure is part of a much larger Liberal election platform that includes $130 billion in new spending measures over the next four years. By the government’s own preliminary tally, the spending will drive the projected budget deficit and debt burden higher in the near-term. That said, the government announced that they will forgo publishing an official federal budget this year. This means we’ll need to wait until the Fall Economic Statement, usually tabled between October and December, to understand the exact impacts on the country’s bottom line.

Meanwhile, Ontario released its FY 2025/26 Budget, officially wrapping up the provincial budget season. New measures related to tariff relief and broader economic support, combined with a contraction in near-term revenues, are expected to put the province’s books into a $14.6 billion deficit for the fiscal year (see analysis). Relative to the size of the economy, Ontario’s projected deficit is in line with those reported by most provinces across the nation (Chart 1). Ontario and Manitoba also signed a Memorandum of Understanding (MOU) supporting the removal of barriers to trade between their two provinces.

Shifting to the hard economic data, Canada’s housing markets continue to show signs of weakness (Chart 2). Existing home sales in April failed to generate any traction as economic uncertainty likely kept buyers on the sidelines despite lower interest rates. With the data we have on hand, we’re tracking another decline in Canadian home sales in Q2 following a sizeable first quarter contraction. The weakness is expected to be temporary. Ample pent-up demand exists and we expect it to start funneling back into markets by the fourth quarter as there is more certainty on the trade front, and homebuyers regain confidence and clarity. Elsewhere, housing starts bounced back in a meaningful way in April after steep declines in the two months prior, though they continue to soften on a trend basis. Ontario, in particular, stands out as construction responds to the past declines in demand.

On tap next week is April’s update on inflation. The print could show stable and easing price growth as the elimination of the consumer carbon tax has pushed energy prices significantly lower. Past this, we expect tariff impacts may start nudging inflation back towards 3% starting in May/June. The Bank of Canada (BoC) is waiting in the wings to make their next policy decision on June 4th and the economic evidence is increasingly painting a picture of a slowing Canadian economy. From our lens, the current situation gives the BoC room to deliver another quarter-point cut to the policy rate at the June announcement.

U.S. – Trade Tensions with China Simmer Down

Following the U.K. trade deal signed last week, the U.S. de-escalated its tariff fight with another key trade partner this week – China. Stock markets rejoiced on the news with the S&P 500 up almost 5% this week.

The U.S. and China announced a temporary truce, which would see both nations significantly reduce their tariffs for 90 days, effective May 14th. U.S. tariffs on China would drop from 145% to 30%, while Chinese tariffs on U.S. goods would fall from 125% to 10%. China also agreed to ease its critical minerals export restrictions. This development marks a major step in the right direction. Still, it is early days in negotiations and there’s potential for trade tensions to flare up again should an agreement prove elusive. Additionally, some of the damage is already done, with elevated tariffs that were kept on for several weeks already disrupting trade patterns and setting the stage for potential price hikes ahead. Recognizing these risks, at a speech this week Fed Chair Powell noted that “we may be entering a period of more frequent, and potentially more persistent, supply shocks – a difficult challenge for the economy and for central banks”.

Up until April, inflation appeared to be moving in the right direction. Helped by a reduction in energy prices, total CPI inflation eased to 2.3% year-on-year (y/y) in April – the lowest level since 2021. Meanwhile, core CPI held steady at 2.8% y/y, but managed to trend lower on a 3-month annualized basis (Chart 1). Still, this trend is unlikely to last. Citing pressure from tariffs, Walmart announced plans to start passing on tariff costs as early as this month. Other retailers are likely to follow, and consumers will soon start to feel the heat.

With respect to the consumer, following a strong finish to the first quarter, retail sales grew only modestly in April. Sales at motor vehicle and parts dealers edged lower (albeit from an elevated level), while sales at gasoline stations fell more noticeably in part due to lower gas prices. Despite this, a decent showing in a few other categories, including bars and restaurants, and building material stores helped provide some counterbalance.

Pulling back the lens, last month’s retail spending data provided further evidence that consumers continued to front-run the tariffs by pulling forward purchases of some big ticket items. Meanwhile, ongoing gains in discretionary spending suggest that the consumer is managing to hold its own for now, despite downbeat sentiment. Housing starts also managed to eke out some modest growth in April (up 1.6% on the month), but under the hood, the details were mixed. Starts in the larger single-family sector continued to trend lower, with last month’s increase entirely stemming from gains in the smaller and more volatile multifamily segment (Chart 2).

All told, the de-escalation in the trade fight with China marks an important step in the right direction, and there could be more on the way, with President Trump today hinting at the potential for further de-escalation with other countries over the next 2-3 weeks. Still, this does not rule out additional flareups, and we are far from being out of the woods.

Summary

United States: Sentiment Is Cratering but Hard Data Signal Only a Stalling

• The 90-day pause with China cheered financial markets, but economic data showed early indications of the economic impact of tariffs. Retail sales held up OK and industrial production was flat, but small business confidence optimism faded. Consumer sentiment plunged to the second lowest on record amid inflation worries.
• Next week: Existing Home Sales (Thu.), New Home Sales (Fri.)

International: Foreign Economies Start 2025 on Surprisingly Solid Note

• This week brought a wave of economic data from both advanced and emerging economies, with several upside surprises on the growth front. The United Kingdom, Norway and Switzerland all posted stronger-than-expected first quarter growth figures, reflecting pockets of resilience despite broader global uncertainty. Japan was the notable outlier, with GDP contracting more than expected. On the emerging economy side, India’s softer-than-expected inflation print was reassuring. Meanwhile, Mexico's central bank lowered its policy rate by 50 bps to 8.50% and signaled further easing to come.
• Next week: China Industrial Production and Retail Sales (Mon.), Reserve Bank of Australia Policy Rate (Tue.), Eurozone PMIs (Thu.)

Credit Market Insights: Here to Collect: Student Loan Delinquencies Surge in Q1

• The Federal Reserve Bank of New York released an update to its Quarterly Report on Household Debt and Credit this week, which included data through Q1-2025. Rising delinquencies point to some modest strain among consumers, and the resumption of student loan payments after almost five years of forbearance comes as the consumer is on somewhat shakier footing.

Topic of the Week: Commercial Real Estate on Stable Ground Before Liberation Day

• The CRE market started 2025 on a positive note. During Q1-2025, transaction volumes, property prices and lending activity all improved against a backdrop of slightly lower capital costs. On balance, vacancy rates across the major property types were lower or ticked only modestly higher, suggesting that the CRE market is on the way to finding balance after several challenging years.

Full report here.

April’s inflation reading for Canada on Tuesday will be distorted again by tax changes with the removal of the consumer carbon tax on energy products at the start of the month. This builds upon previous distortions caused by the federal GST tax break between December 2024 and February 2025.

We expect (after-tax) price growth in the Canadian consumer price index to drop to 1.6% in April from 2.3% in March, largely due to the removal of the carbon tax. Gasoline prices plummeted by 10% nationally in April from March, and we expect consumer natural gas prices plunged 27%.

The underlying inflation trend (controlling for the tax change) will be closely monitored after March data showed a moderate downside surprise, breaking a five-month streak of mostly upside surprises.

The April inflation data is unlikely to show significant pressure from import tariffs yet, and we expect import substitution to alternative sources and consumer substitution to non-tariffed products will ultimately limit the impact of Canadian retaliatory tariff measures on consumer prices (see issue in focus here).

Still, we expect food price growth to remain elevated at about 3.2% year-over-year in April like March. Core inflation (excluding food and energy) is projected to rise to 2.6% from 2.4%. Annual growth in the Bank of Canada’s preferred median and trim measures, which exclude the impact of tax changes, should hold steady, just under 3%.

March’s Canadian retail sales figures released next Friday will be closely watched for signs of shifting spending patterns driven by tariff anxieties. Statistics Canada’s advance indicator showed a 0.7% monthly increase, fully reversing February’s 0.4% decline. March’s upturn was largely powered by a surge in auto sales as consumers purchased vehicles ahead of anticipated tariffs. Auto sales pulled back in April, according to early industry reports, but our tracking of broader consumer spending trends remained resilient compared to consumer sentiment.

Week ahead data watch

• Strong dollar awaits Fed speakers and PMIs.
• RBA to cut by 25bps, focus to fall on forward guidance.
• Sticky UK inflation could mean only one more BoE rate cut.
• Eurozone PMIs, Canada’s and Japan’s CPI numbers also on tap.

US-China deal boosts investors’ appetite

Risk sentiment improved significantly this week, while the dollar strengthened, after trade negotiations between the US and China ended with unexpectedly substantial progress. The world’s two biggest economies agreed to lower tariffs by 115% for 90 days, which means that during that three-month truce period, China will charge US goods with a 10% rate, while the US will tax its Chinese imports at 30%.

The better-than-expected accord significantly eased recession fears, with investors scaling back their Fed rate cut bets. From penciling in more than 100bps worth of reductions this year just after Trump’s ‘Liberation Day’, they are now expecting only 57, getting closer to the Fed’s latest ‘dot plot’, which pointed to 50bps worth of rate cuts by December.

Fed officials and US PMIs to shed light on Fed’s plans

Following this week’s CPI data, which revealed that underlying price pressures in the US remained sticky in April, next week, traders will monitor the preliminary PMIs for May on Thursday, but they may also pay attention to speeches by several Fed members as they may want to hear whether the Committee remains concerned about economic growth or whether they are more focused on the inflation outlook now the US has found some common ground with China.

Rising PMIs may suggest that sentiment among businesses has improved after the US-Sino deal, but investors may want to hear clear remarks about how the Fed is planning to move forward. Among the speakers will be New York Fed President John Williams, Atlanta Fed President Raphael Bostic, Dallas Fed President Lorie Logan, and San Francisco Fed President Mary Daly. If they remain concerned about the upside risks of inflation, the dollar could extend its gains as traders could price in even fewer rate cuts.

How the stock market may respond is not so crystal clear. We’ve seen equities gaining lately, even as market participants have been scaling back their rate cut expectations, mainly because the latest tariff-related developments have been easing anxiety regarding a recession. However, given that a recession is not so prominent now and a higher-for-longer rate narrative is based on concerns that inflation may prove to be hotter than expected, Wall Street may pull back should Fed officials highlight upside risks to inflation.

Will the RBA sound less dovish than expected

On Tuesday, the Reserve Bank of Australia (RBA) will hold its first monetary policy decision after Trump’s ‘Liberation Day’, as its prior meeting took place just the day before. Back then, the Bank kept interest rates unchanged, with Governor Bullock saying that no reduction was discussed as their top priority was inflation’s return to their target.

Since then, data showed that inflation was stickier than expected in Q1, but the overall uncertainty surrounding the global economic landscape due to Trump’s trade policies has led investors to pencil in around 80bps worth of reductions by the end of the year. For next week’s decision, a quarter-point reduction is nearly fully factored in.

Therefore, a rate cut on its own is unlikely to be a strong driving force for the aussie. Traders may direct their attention to clues and hints about how policymakers are planning to move forward. With underlying inflation metrics near the upper bound of the Bank’s 2-3% target range and taking into account the US-Sino trade deal, policymakers are unlikely to corroborate the ultra-dovish market consensus.

Yes, the Bank will likely keep the door to further reductions open – after all inflation is within the target range – but there is no data justifying 80bps worth of rate cuts by the end of the year. Thus, a less-dovish-than-expected message may allow the aussie to gain some more ground.

Ahead of the RBA decision, aussie traders may cast a glance at China’s data, due out on Monday. Industrial production, fixed asset investment and retail sales, all for April, will be released. That said, given that the data will refer to a period before the latest US-China trade deal, when tariffs were above 100%, investors may not take the numbers at face value and thus, any market impact may be limited and short-lived.

Hot UK CPI could mean only one more BoE cut

In the UK, the CPI data for April, the preliminary PMIs for May, and retail sales for April will come out on Wednesday, Thursday and Friday, respectively. On May 8, BoE officials decided to cut interest rates by 25bps, but the decision was far from unanimous. Five members supported the quarter-point cut, while two voted for a bigger 50bps decrease and another two for keeping rates steady.

The BoE said that tariffs could weigh on economic growth, but the outlook was still unclear. “That’s why we need to stick to a gradual and careful approach to further rate cuts,” Governor Andrew Bailey noted. Coming hot on the heels of the US-UK accord, the less-dovish-than expected outcome prompted investors to reduce the amount of rate cuts expected by the BoE this year from 75 to currently 45 basis points.

So, should the data point to sticky inflation, improving PMIs, and robust retail sales, investors may become more convinced that only a single quarter-point cut remains in the Bank’s chamber, which could propel the pound higher.

Eurozone PMIs, Canadian and Japanese CPI inflation

Besides the US and the UK preliminary PMI data, Thursday’s agenda includes the Eurozone numbers as well. After cutting interest rates by 25bps at its previous meeting and warning that economic growth will take a big hit from US tariffs, the ECB is widely anticipated to cut by another 25bps in June, but only one more reduction is priced in for the remainder of the year.

This may be due to the improving global trade environment, especially after the US-Sino deal, and due to recent remarks by ECB member Isabel Schnabel that interest rates should remain close to current levels. Therefore, a round of improving PMIs could corroborate Schnabel's view and add extra support to the euro.

Canada and Japan also release their April CPI reports on Tuesday and Friday, respectively. The Bank of Canada remained on hold back in April, its first pause after seven consecutive cuts, adding that they remain ready to act if needed. With the jobs market losing around 33k jobs in March and failing to recover in April, the unemployment rate rose to 6.9% from 6.7%, prompting market participants to assign a 65% chance of another 25bps reduction at the June gathering. With the CPI already within the Bank’s 1-3% target range, further slowdown in consumer prices could solidify the case of a June rate cut and thereby weigh on the loonie.

As for the BoJ, its latest decision was less dovish than expected but still, investors are assigning a decent 70% chance of another quarter-point hike by the end of the year. Although the economy contracted in the first quarter, the Tokyo CPI figures for April accelerated strongly, suggesting that the National prints could move in a similar fashion and thereby add more credence to the case of another rate hike by the BoJ in 2025.

• US and China agree to lower tariffs for 90 days as tensions take toll.
• But what are the prospects for a permanent deal?
• Markets are unsure if this is a true turning point.

Boiling point

The trade war between the United States and the rest of the world reached a boiling point in April after President Trump unveiled reciprocal tariffs that were far greater than what anyone was expecting and as he flagged a new round of sectoral tariffs. The response by other countries varied, with many, like Australia, Japan and the United Kingdom, deciding not to retaliate. But others, such as the European Union and China, have not held back in responding with some counter measures.

China’s response has been the most aggressive, likely taking the White House by surprise. As expected, though, the tit-for-tat retaliation only infuriated Trump, escalating into a full-blown trade conflict. Prior to the weekend talks between US and Chinese officials aimed at diffusing the situation, Chinese businesses were staring at a staggering 145% tax on their exports to the US, while American imports were being charged a somewhat lower 125% rate.

Stepping back from the brink

All this suggests that a truce was inevitable. Reports on who initiated the talks vary, depending on the source. But most likely, both sides were seeking an urgent de-escalation, as such punitive tariffs can only be harmful to the world’s two largest economies. Hopes were high heading into the weekend meetings in Switzerland as Trump had hinted that he was willing to lower tariffs on China to 80%.

In a huge relief for investors, the outcome was far better than expected, as both sides agreed to slash each other’s tariffs by 115%, bringing the rate on Chinese imports to 30% and the rate on US goods entering China to 10%. Not forgetting the sectoral tariffs on steel and cars, this leaves the average level of levies between the two countries still above what it was prior to the start of the trade war in February.

No end to the uncertainty

More concerning for investors and other decision makers, especially business leaders and central bank policymakers, is that the temporary reprieve does little in removing the uncertainty. Reaching an initial trade deal was probably the easy part. Agreeing on a comprehensive trade pact that resolves differences on key areas such as intellectual property rights, the illegal flow of fentanyl and US access to Chinese markets will be much more difficult.

This leaves markets exposed and vulnerable to any potential setbacks during the 90-day pause, while failure to reach a more permanent agreement risks reviving fears about a US and global recession.

Dollar perks up

The easing trade tensions have helped the US dollar recover significant lost ground. The dollar index surged towards its 50-day moving average (MA) the day after the Sino-US deal was announced, extending its rebound from April’s three-year low of 97.92 to more than 4%. However, the 50-day MA has proven to be a tough obstacle to overcome, and the greenback has since retreated somewhat, casting doubt about its outlook even if trade frictions continue to de-escalate.

Inflation risks persist

Apart from the ongoing risk that Trump could re-impose some of the suspended tariffs at any point, there is also huge uncertainty about what will happen to inflation. For now, US inflation appears to be gradually declining, putting the Fed in a strong position to resume its rate cuts at some point in the second half of the year.

However, the Trump administration has repeatedly indicated that the 10% baseline tariffs that were introduced on April 2 are here to stay. The 25% duties on specific sectors are also not likely to be abolished completely, even if there are some further exemptions in the future. Plus, tariffs on additional industries are possible.

This makes it difficult for the Fed to feel confident about inflation maintaining its current downward path as there’s bound to be some impact from the higher tariffs on US prices even in the best cast scenario. Investors currently foresee just two rate cuts this year, with a full 25-basis-point reduction not fully priced in until September.

Fed still faces a dilemma

A long pause seems more justifiable now that exorbitant tariff levels have been scaled back and no longer pose a threat to the economy. But then why is the dollar’s rebound looking shaky?

It’s likely that investors still see a significant risk of stagflation, as the uncertainty about Trump’s policies will probably hold back business and consumer spending to some extent, suppressing growth while costs go up. It’s also the case that the supply chain landscape will go through an inevitable transformation, as many businesses will be forced either way to shift some or all of their production to the US, pushing up costs.

A China deal may not be easy

Investors should not be fooled into thinking that America’s quest to decouple from China will stop when Washington and Beijing finalise their deal, which itself may not bring an end to the broader economic war.

One reason why Trump is coming down hard on China in his second term is because of the failure of the Phase I agreement signed in January 2020 during his first term. The Chinese did not live up to their commitment of buying more US goods, so the White House will be wary not to repeat the same mistake and will seek better safeguards for enforcement of the deal.

Hence, the stakes are a lot higher this time, meaning a resolution of the trade dispute may take a lot longer than anticipated. This explains why many investors are maintaining a substantial degree of caution until there is a more convincing breakthrough in the negotiations.

Reason for optimism

Nevertheless, some optimism in the short term is warranted, as all the signs suggest the Trump administration wants to avoid another stock market meltdown and is determined to get more preliminary deals across the finish line. It’s also highly likely that the existing 90-day delays on reciprocal tariffs will be extended, while the evidence from the latest announcements on the chip and pharmaceutical sectors is that the White House is toning down its stance amid outcry from industry leaders.

For the dollar, a break above the 50-day MA is vital if the recovery is to gain any traction, with the next critical barrier likely to be found around 103.35, followed by the 200-day MA. Though, the 200-day may be too bullish a target at the moment as downside risks persist.

Doubts about Dollar’s reserve currency status

Trump’s constant flip-flopping on trade and undermining of America's democratic institutions is harming the dollar’s position as the world’s reserve currency. This may limit the dollar’s advances even if there is a further cooling in trade tensions.

But in the event that there is a re-escalation in the trade war and Fed rate cut expectations are ratcheted up, there is scope for the dollar index to slide all the way down to the 94.60 region towards 2021 lows.

This week has been dominated by risk-on sentiment in markets following the positive outcome of the US and China trade negotiations during the weekend in Geneva. The cuts to tariff rates were larger than we and consensus had anticipated as the US announced a 115-percentage point reduction of the previous tariff rate from 145% to 30%. Adding the 10% universal tariff rate Chinese goods are now faced with a 40% tariff when entering the US compared to around 10% before Trump took office. We estimate there is a good chance of the US cutting tariffs by an additional 20 percentage points by striking a deal on the Fentanyl issue. Following the announcement, the risk of a recession in the US has been significantly reduced and we estimate that growth will likely experience a hit of around 0.5 percentage points which is manageable. For more details, see US-China Flash - Trade talks succeed in de-escalation, 12 May, and join our webinar on 21 May.

On the data front, we received a host of data this week from the US. Inflation data for April surprised slightly to the downside as headline inflation declined to 2.3% y/y (cons: 2.4% y/y) from 2.4% y/y and core inflation remained at 2.8% y/y, as expected. There was little evidence of tariff-driven price pressures, as core goods inflation remained slow (+0.06% m/m) and food prices even declined slightly (-0.08% m/m). Interestingly, core services inflation excluding shelter and healthcare remained negative for the second consecutive month (-0.02% m/m), which suggests that underlying price pressures have remained in check despite the trade war - a conclusion that was also supported by the April PPI data. The trade war does not seem to have caused US consumers to be significantly more cautious when evaluating the latest retail sales data for April. Retail sales recorded a small monthly decline in the control group due to weaker spending on clothing and electronics, while spending on restaurants and bars continue growing at a solid pace. We think the weak retail sales figure might reflect reversal of front-loading effects more than true underlying weakness.

In the euro area, data showed that employment continued to grow in the first quarter of the year, rising 0.3% q/q after growing 0.1% q/q in Q4 2024. Hence, the labour market continues the strong footing it has been on in the past years despite weak economic activity. Employment growth was once again driven by Spain that recorded 0.8% q/q higher employment while both France and Germany reported unchanged employment in Q1. The strong labour market is a hawkish argument for the ECB. In Germany, the final inflation data for April showed that much of the increase in core inflation was due to the timing of Easter pushing up costs for package holidays and airfares, which suggests the increase in April should be seen more as a one-off than a resurgence of price pressures in core services.

Next week, focus turns to the May PMI data for the US and euro area, which will be interesting to follow as they previously have remained stronger than feared amid the trade war uncertainty. On Monday, China releases a large batch of data for April, which will show the impact of the peak escalation of trade tensions, and the central bank announces its interest rate decision, and so does the Australian central bank. In Japan, we will receive inflation data on Thursday, and in the euro area we focus on the negotiated wage growth data for Q1 released on Friday and the EU Commission's economic forecasts on Monday.

Full report in PDF.

Key insights from the week that was.

In Australia, Westpac-MI Consumer Sentiment rose 2.2% to 92.1% in May, representing a partial rebound from a subdued result in April that partly captured President Trump’s ‘Liberation Day’. There have been many developments on the global trade front since – especially the latest de-escalation between the US and China which came just after our latest survey – which, combined with the calm attitude of financial markets, have supported sentiment. This was clearly captured in views on ‘family finances vs a year ago’ which rebounded +7.0% and, to a lesser extent, the year-ahead outlook for economic conditions, up +2.8%.

Consumers are accordingly less downbeat on whether it is ‘time to buy a major household item’, up +3.5%; however, that the sub-index remains 25% below its long-run average emphasises the weak starting point for the nascent recovery in consumer spending after a prolonged period of real income declines over 2023/24. On that front, the latest wages data struck a more positive tone for households, with the wage price index rising 0.9% (3.4%yr) in Q1. This was slightly firmer than expected and came as a result of wage increases delivered to aged care and childcare workers.

Households also remain positive on the labour market outlook, a view that was certainly given justification by the latest labour force survey. Following a couple of months of softer outcomes, employment surprised materially to the upside with an +89k surge. This also came alongside a significant rebound in the labour force, seeing the employment-to-population ratio and participation rate bounce back toward their historic highs. Meanwhile, the unemployment rate was little changed at its current year-average of 4.1%. Broadly, labour demand and supply still look to be moving broadly in tandem, allowing measures of labour market slack to hold steady.

Overall, this week’s data does not change our view that the RBA will deliver a 25bp rate cut at its policy meeting next week, but it will be interesting to see refreshed staff forecasts and the Board’s framing of risks around the domestic and global outlook. We note that the latest NAB business survey highlighted businesses were broadly unphased by the US’ tariff uproar, supporting the view that Australia remains well placed to weather this period of global uncertainty. And, as far as the latest US-China trade deal is concerned, this week’s essay from Chief Economist Luci Ellis discusses the implications in more depth.

Offshore, investors were focussed on the short-term trade deal agreed between the US and China. Tariffs imposed on Chinese exports were reduced to 30% (combining a 10% reciprocal rate and 20% tariff for fentanyl supply), while China will tariff US goods by 10%. These rates will be in place for 90 days from 12 May during which time the leaders of both countries will seek to negotiate a more permanent trade agreement. Industry tariffs also remain in effect for Chinese imports to the US, as is the case for other nations.

On the data front, the US CPI printed below expectations at 2.3%yr in April, the lowest rate since February 2021. Annual core inflation held steady at 2.8%. The detail of the April report was mixed, food prices edging higher as energy posted a partial rebound (a 0.7% gain after March’s 2.4% decline). Within the core basket, goods prices edged higher again (up 0.1% in the month and over the year). Services inflation meanwhile remained robust at 0.3%, 3.6%yr (ex energy). Shelter inflation (primarily rents) continues to track materially above average, a consequence of limited supply; but medical care services also saw an outsized gain 0.5% compared to its current annual pace of 3.1%yr. Overall, ahead of the impact of tariffs, the baseline for inflation in the US looks to have been inflation modestly above target, primarily as a result of constrained supply. This is not a trend that the FOMC can easily influence; but, as tariffs also impact, it will give the FOMC cause to be cautious over inflation expectations and risks.

FOMC members who spoke this week certainly supported a ‘wait and see’ approach to monetary policy. Although, it has to be noted, they are assessing the labour market as closely as inflation. We maintain our call for two rate cuts towards the end of 2025 and an on-hold stance through 2026 while awaiting a clearer read on the net effect of US domestic and trade policy.

In the UK meanwhile, the latest labour market data gave justification for the Bank of England to continue to ease through 2025. The three-month average pace of employment growth slowed to 112k in March, down from 206k in February; and the unemployment rate edged up from 4.4% to 4.5%. Annual growth in average weekly earnings decelerated from a revised 5.9%yr ex-bonus to 5.6%yr (3-month average basis). This deceleration in wages aligns with other survey indicators which indicate wage growth is unlikely to be a source of inflationary pressure over the coming year.

While there may be greater concern over US growth these days, for both the UK and Euro Area, the outlook is becoming brighter. UK GDP growth was strong as expected in Q1, gaining 0.7%, 1.3%yr. This is despite soft private consumption (0.2%) and a contraction in government spending (-0.5%), more than offset by a surge in business investment (2.9%) as export growth outpaced imports (3.5% versus 2.1%). The second release for Q1 Euro Area growth confirmed robust moment, quarterly growth edged down from 0.4% to 0.3% but the annual rate unchanged at 1.2%yr – around trend.

The balance of growth prospects between the US, UK, Europe and, further afield, Asia will have a material bearing on the outlook for financial markets. Current trends point to persistent downward pressure on the US dollar, as discussed recently in our May Market Outlook.