US and EU strike post-Liberation Day trade deal

The dollar traded lower against most currencies last week as market participants became increasingly jittery ahead of Friday’s looming tariffs deadline.

Progress towards the striking of trade deals has been painfully slow since Liberation Day. We are, however, finally seeing some tangible headway, not least following last week’s headlines that the US and Japan had signed a long-awaited trade deal. This was followed by even bigger news over the weekend that the European Union had secured a framework deal with the White House that will also see the imposition of 15% tariffs on most goods, ending months of feverish speculation and acute uncertainty.

News of the latter will be a particularly welcome development for markets, which had braced for the possibility of significantly higher tariffs in both directions that would have likely had a major impact on the global economy. While many details of the deal are yet to be ironed out, and the tariffs themselves will still likely have a non-negligible downside growth impact, investors will just be pleased that the worst-case scenario has been avoided.

Action in the FX market this week will no doubt be driven by the fallout from the trade deals, and any news of progress in last-minute negotiations with other countries. Markets will also have the small matter of the July FOMC meeting to digest on Wednesday.

GBP

Sterling continued to lag behind most of its major counterparts last week, as another batch of underwhelming economic data ramped up fears over the health of Britain’s economy. The June retail sales figures and July business activity composite PMI all surprised to the downside, and remained consistent with an economy that is stuck squarely in stagnation. News that the UK government borrowed more than expected in June will also do nothing to ease pressure on Chancellor Rachel Reeves, who will almost certainly need to raise taxes again in the autumn in order to avoid a fiscal catastrophe.

The rapid deterioration in the economy puts the Bank of England in a quandary, and begs the question as to whether the MPC will prioritise propping up growth and the jobs market, or maintaining price stability. While we think that a 25 basis points rate cut remains highly likely in August, fears over the latter could ensure no more than a gradual pace of rate reductions beyond then.

EUR

Reports that the EU was close to striking a framework trade deal with the US kept the common currency well bid last week. Equity markets have reacted positively to the news of the deal so far today, although the moves in the euro have been subdued, given that an agreement was already heavily priced in. The European Central Bank provided no real surprises last week, as it held rates steady and reiterated that policy was in a “good place”. Yet, Lagarde’s tone was moderately more hawkish than we had expected, as she both expressed confidence on inflation and made no attempt to talk down the value of the euro.

Now that a US-EU trade deal is secured, we’re pretty confident that the ECB will stay on hold for at least the next couple of meetings, and it's not out of the realm of possibility that the council has delivered its final cut in the current cycle. Preliminary Q2 GDP figures and July inflation numbers will be released on Wednesday and Friday respectively, but the euro will likely be driven more by the fallout from the trade deal than anything else.

USD

The US economy continues to show no signs of letting up. Businesses appear largely resilient to the uncertainty created by Trump’s tariffs, at least according to this month’s composite PMI from S&P, which jumped to its highest level since December. We’re also not seeing signs of mass layoffs in the labour market, with last week’s jobless claims figures dropping to the lowest levels since April. It's somewhat of a surprise that the recent strength of the US economy has not yet been reflected in a stronger dollar, but this may merely have been a reflection of lingering jitters ahead of this Friday’s tariffs deadline.

Trade developments aside, markets will be keeping an eye on Wednesday's FOMC decision. While we expect no change in rates, we could see a couple of rare dissenting votes in favour of an immediate cut. Chair Powell is, however, likely to kick the can down the road, stressing again that more data on the economic implications of the tariffs will be required, and that the Fed will have greater clarity after the summer.

 

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