Market Brief: Dollar grinds higher into quarter end

In the absence of any major volatility catalysts, the dollar is adding to its gains and Treasury yields are holding firm, with equity futures pointing to a flat open. Oil prices have fallen back to levels last seen before the US-Israeli-Iranian conflict began at the end of February, and the skirmishes that continue to flare are drawing diminishing reactions from markets—a sign that traders have moved on from the war as a primary driver and are trading the macro picture instead.

Treasury markets barely reacted yesterday when the Supreme Court blocked President Trump's effort to fire Federal Reserve governor Lisa Cook, underscoring a growing sense that threats to the central bank's independence are receding into the background. Chief Justice Roberts wrote that allowing the president to remove a Fed governor at any time, without notice or judicial review, would be "out of step with the statute Congress enacted" and the nation's tradition of shielding central banking from political interference. The ruling considerably narrows the administration's near-term ability to reshape the Fed, with no vacancies on the Board until Jerome Powell's term expires in January 2028. For currency markets, the implication is straightforward: monetary policy will be set by the committee's reading of the data, not by the White House's preferences, for some time to come—something that should reduce inflation risks and help keep long-term interest rates well-anchored.

The yen is trading near a 40-year low against the dollar but is outperforming most of its major peers, having fallen less than other major currencies this month in the face of intervention threats from Japanese authorities. In comments last night, Finance Minister Satsuki Katayama avoided the verbal escalation that often precedes a buying effort, instead reiterating that authorities stand ready to respond at any time. Her language was measured, but we would note that Thursday's non-farm payrolls report and Friday's Independence Day holiday—when US liquidity will thin dramatically—could provide attractive opportunities for wrong-footing speculative short positions.

The euro and pound are each trading above key support levels. National French and Italian, along with state-level German inflation updates this morning showed price growth cooling slightly, giving the European Central Bank room to hold off on further rate increases*. Across the Channel, presumptive prime minister Andy Burnham avoided ruffling feathers in the gilt market with yesterday's speech, promising a devolution of powers from Westminster while pledging to maintain sound public finances and follow the current fiscal rules.

The coming days could be eventful, with a dense slate of US data landing against a choppy trading backdrop. Today brings the latest job-openings update and Conference Board consumer confidence survey, tomorrow the ADP employment report and ISM manufacturing index, and Thursday, the all-important non-farm payrolls report. Each release will be scrutinised for signs of whether the US economy is as resilient as the Fed's June projections implied. We think expectations for higher rates from the Fed are nearing a peak—and if we're right, the dollar may ultimately fail to fully recoup its post-Liberation Day losses. The hawkish repricing has been sharp, but it has been built on a narrow base of strong data and a single press conference. It would not take much to shake it.

Here in Canada, the exchange rate is holding near a 14-month low ahead of this morning’s gross domestic product report, which is expected to show the economy expanding 0.4% month-over-month in April—confirming the earlier flash estimate and pointing to a modest second-quarter rebound after a near-flat, recession-flirting first quarter. This should reinforce the Bank of Canada's case for holding rates at 2.25%.

We don't see tomorrow’s CUSMA review date as a binary risk event for the loonie. Currency traders are unlikely to react dramatically to an event that has been foreseeable for a long time**. If the US doesn't agree to an extension, the agreement does not terminate—it simply reverts to annual reviews that can continue until 2036—but there are real risks associated with the negotiations that are set to get underway.

In order of likelihood, we think three scenarios are possible over the coming months:

‘Zombie’ agreement (75%): The parties fail to agree on an extension and the deal continues to operate, with major issues left unresolved even as Washington, Ottawa and Mexico City cut smaller side deals with one another. The US gets a steady stream of headlines trumpeting incremental wins, import prices avoid a disorderly rise, and the administration generally escapes political blowback. North of the border, uncertainty remains elevated, the Canadian economy continues to struggle with weak consumption and low investment, and the loonie struggles to break back into the 1.30s without a broader reversal in the US dollar itself.

Negotiated renewal (20%): after prolonged negotiations, the three parties agree to extend the agreement for another 16 years, with Canada and Mexico making concessions on US demands—stricter rules of origin, procurement provisions at the federal and provincial level, dairy supply management, and digital and streaming regulations. Some sectors of the Canadian economy shoulder severe adjustment costs, but growth remains positive and the Canadian dollar climbs back into the mid-1.30s as uncertainty dissipates and the long-term outlook improves, giving households and businesses reason to spend and invest once again.

Outright withdrawal (5%): the US gives six months' notice of its intent to withdraw unilaterally and then raise tariffs on Canada to levels comparable with other trading partners. This pushes Canada into recession, raises unemployment and sends the Canadian dollar toward 1.50 or beyond. But the costs don’t flow in one direction. A move of this magnitude intensifies an already-strong US inflation impulse, raises uncertainty for businesses in a number of battleground states, and hands the opposition a potent line of attack ahead of midterm elections in which the administration is already at risk of losing both chambers of Congress.

Regardless of which scenario prevails, the future of Canadian trade policy and the direction of the loonie are unlikely to reach a clean resolution in the days ahead. For businesses managing cross-border exposures, the uncomfortable truth is that the uncertainty*** itself—not any single outcome—is the condition that much be hedged.

Please note: distribution of the morning Market Brief will pause tomorrow for the Canada Day holiday. We will, of course, be watching markets and will provide updates should any major shifts occur.

*Central banks generally avoid delivering isolated moves. Rate cuts and hikes tend to come in sequential clusters as officials follow gradualist policy trajectories, seek to maintain credibility, and try to avoid the appearance of having made mistakes. Exceptions are rare—the Federal Reserve hiked once in 1997 before moving to the sidelines for 18 months, the Bank of Canada cut once in January 2015, delivered a second move in July, and then stayed on hold for almost two years—but they do exist. The ECB's June hike could prove to be another.

**This may, admittedly, overestimate the intelligence of currency traders. This happens surprisingly often.

***Ironically, if the US wanted to implement a policy that increased the competitiveness of Canadian exporters through currency depreciation, it wouldn't look much different than what we're seeing.

Market Overview

Data as of 7:15 AM EDT

Notes: DXY: Dollar index, DMA: Daily Moving Average, Pivot points are calculated on a one-month basis, 3-month and 10-year spreads are against USD, Implied V.: implied at-the-money option volatility

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