US
A big part of the bearish Dollar case is that US firms and households will end up covering most of the tariff costs, which should drag on relative US performance. Alongside broader policy uncertainty, I think investors will keep cutting Dollar exposure. Next week’s CPI release to give a clearer read on how this is shifting.
This hit to the US could be sharper in some of the new sectoral tariffs, especially on goods that are harder to replace, which fits with the initial move in copper. I think the limited market reaction to these reflects two things. First, markets have little conviction these tariffs will actually be applied. We have already seen several cases this year where proposed rates were simply too high to stick, avoiding the cycle of tighter conditions followed by a policy climbdown. Second, when the US has targeted a single country in the past, the Dollar has often gained against that currency, which is different to the pattern when the US hits multiple trading partners at once. If we do get broad hikes again, I think the Dollar would come under pressure. Over time, this should add to the perception that US policy makes it harder for firms to operate and for foreign investors to commit capital. It also lines up with FX moves so far this year, where flows have been a major influence. I think that quicker Fed cuts and the Dollar’s link to risk could shift hedging and allocation patterns further.
AUD: Cautious RBA
The RBA held rates in July, surprising some given earlier dovish hints, including the fact they had looked at a 50bp cut in May. The AUD barely moved on the decision, and terminal rate pricing only edged higher. I still think the domestic backdrop supports more easing, just at a slower pace. As with most G10 currencies, global risk sentiment and Fed policy are bigger drivers than domestic settings.
The Fed is starting to matter more again for the USD, with the next cut now seen sooner and the terminal rate lower on softer inflation and weaker activity data. If the RBA eases into this backdrop, without a sharp negative growth shock, FX reaction will probably look more like a standard dovish adjustment than a risk-off move. In that kind of scenario, my bias is for outperformance in NZD, the Scandis, and AUD.
FX Volatility
FX implied vol has eased in recent weeks on softer US data and fading tail risks around recession and inflation. I think this makes sense for now, but it could turn quickly, and shifts in capital flows could also push vol higher.
US macro uncertainty has been the most important driver of vol, with CPI uncertainty leading recently and monetary policy close behind. This supports the idea that lower vol is justified, especially in EUR/USD, but if inflation uncertainty climbs again, implied vols should rise. Broader flow dynamics could also matter in ways that standard implied vol models do not capture.
-William Lun
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