Market Brief: Dollar's Decline Remains Intact Even As Risk Backdrop Worsens

The dollar is up slightly this morning, but remains on course toward its worst year-to-date performance in this century, even as geopolitical risks simmer in the background and the Federal Reserve grapples with a raft of potential inflation risks. Yields are under pressure, equity markets are headed for a mixed open, and measures of risk sentiment are softening ahead of an expected Israeli assault on Tehran later today — as well as tomorrow’s all-important Fed meeting.

American consumers turned slightly more cautious in May, paying little heed to a 90-day tariff pause announced by the Trump administration — and the subsequent market rally — as they cut spending on a range of discretionary household inputs. According to figures published by the Census Bureau this morning, total receipts at retail stores, online sellers and restaurants slipped -0.9 percent on a month-over-month basis in May, after a -0.1-percent loss in the prior month, disappointing investors who were expecting a more modest -0.1-percent monthly headline contraction. So-called “control group” retail sales — with gasoline, cars, food services, and building materials excluded — rose 0.4 percent, overshooting forecasts set at -0.1 percent, and accelerating from a -0.1-percent drop in the previous month.

Vehicle and building materials sales dropped sharply after jumping in prior months as consumer attempted to front-run tariff increases, but evidence of widespread price gains remained difficult to see. Most economists expect that to change as the lagged effects of the trade war work their way through supply chains over the coming months.

Oil prices climbed last night when Donald Trump told the 9.8 million inhabitants of Tehran to “immediately evacuate” and left the Group of Seven meeting early — suggesting that preparations for an attack were underway — but remain distinctly rangebound as traders bet that the conflict will leave global supply and demand balances largely unchanged. Both sides appear to be intent on avoiding wider economic disruption: Israel has not targeted Iranian export infrastructure — like the loading terminals on Kharg Island — and Tehran has not attacked shipping through the Strait of Hormuz.

Oil markets also remain well-supplied, with the OPEC group of producing countries sitting on more than enough spare capacity* to offset Iranian output in the short term. In its monthly oil market update, published this morning, the Energy Information Administration said it sees weak Asian demand intersecting with continued production growth to drive global inventories higher through the course of the year. The Brent and West Texas Intermediate benchmarks are each up roughly 7 percent from the levels that prevailed ahead of the recent outbreak in hostilities, and could go substantially higher yet if conditions escalate, but that is widely understood to be a tail risk, with a gradual cooling in tensions and prices forming the core base case for most market participants.

The yen is trading on a slightly firmer footing and yields are incrementally higher after the Bank of Japan left interest rate settings unchanged, surprising no one. In comments during the post-decision press conference, Governor Kazuo Ueda highlighted upside risks to inflation — setting the stage for a rate hike in the coming months — but also noted that measures of underlying price growth were not accelerating and pointed to major unresolved questions ahead that could impact rate settings, saying “The fallout from trade uncertainty could weigh on companies' winter bonus payments and wage negotiations next year”. “Even if developments surrounding US trade policy stabilise toward a certain direction, there's very high uncertainty on how that could affect the economy."

In a widely anticipated move, officials also responded to turmoil in long-term bond markets by announcing plans to slow balance sheet reduction efforts next year. Under an extended quantitative tightening plan, the Bank will continue reducing purchases of Japanese government bonds by 400 billion yen per quarter through March 2026 before cutting them by a smaller 200 billion yen per quarter from April 2026 forward. Ueda acknowledged that the Bank’s concerns about volatility in long-dated bond yields and its economic consequences had motivated the policy shift, suggesting (to us) that the country is beginning to reach a state of “fiscal dominance” — when government debt levels become so large that they influence monetary policy decisions — and providing a clear warning sign of what could unfold in other advanced economies in the coming years.

*Defined as the volume of crude production that member states can bring on within 30 days and sustain for at least 90 days

Economic Calendar