Market Brief: US Consumer Demand Holds Up, Supporting The Dollar's Rate Premium

The Federal Reserve’s preferred inflation measure climbed as expected in August and personal income and spending numbers beat forecasts, making it more difficult to justify an aggressive course of rate cuts in the coming months. Data released by the Bureau of Economic Analysis this morning showed the core personal consumption expenditures index rising 0.2 percent from the prior month, closely matching market estimates. On a year-over-year basis, core price growth held at 2.9 percent, also aligning with economist forecasts for a 2.93-percent increase. The overall personal consumption expenditures index climbed 0.3 percent relative to the prior month, and was up 2.7 percent from a year ago. Perhaps most critically for the US consumer-led economy, nominal personal income rose 0.4 percent month-over-month, and household spending climbed 0.6 percent, beating forecasts that had been set at 0.32 percent and 0.46 percent, respectively.

The data broadly align with the generally-positive reassessment of underlying consumer demand that has unfolded in recent weeks, and the dollar is holding near a three-week high while ten-year Treasury yields flirt with the 4.16 percent mark as traders further reduce bets on a series of sequential rate cuts from the Fed in the months ahead. US rates have climbed in recent weeks as economic data surprises have lurched into positive territory, and an improvement in relative interest differentials has put renewed momentum behind the greenback , wrongfooting speculators who were convinced the currency would resume its descent in the back half of the year.

But tariff uncertainty remains a lingering risk. With customs systems experiencing delays, and businesses running down inventories, postponing shipments, and using stockpiling strategies to delay charges, we estimate that the applied rate climbed to 11.2 percent in August—higher than in prior months but still well below the 16.5-to-17.5 percent level implied under current policy. Adding to the pressure, Donald Trump unveiled a new round of “national security” tariffs last night, targeting pharmaceuticals, furniture, and heavy trucks. Posts on his Truth Social platform indicated that the U.S. will levy a 100 percent charge on branded pharmaceuticals, a 50 percent duty on kitchen cabinets, bathroom vanities, and related goods, a 30 percent tariff on upholstered furniture, and a 25 percent tariff on semi trucks. The economic effects are likely to materialize with a lag, meaning that today’s “sugar boost” could fade in the months ahead.

Separately, the Canadian economy expanded more than forecast in July, suggesting that growth rebounded at the beginning of the third quarter, even as a flat estimate for August dampened expectations. Numbers released by Statistics Canada this morning showed real gross domestic product growing 0.2-percent on a month-over-month basis in July, topping market expectations - and the agency’s own preliminary estimate - for a 0.1-percent gain. On a year-over-year basis, this amounted to a 0.9-percent expansion, suggesting that a recession is unlikely to have gotten underway. An early estimate showed activity remaining largely unchanged in August, with losses in resource extraction, manufacturing, transportation and warehousing offset by a snapback in wholesale and retail trade.

The Canadian dollar is trading incrementally higher as expectations for the country’s growth trajectory improve on the margins, leaving Bank of Canada forecasts largely unchanged. Just one quarter-point rate cut is now priced in for Canada over the next year, but the number expected in the US has come down in the last two weeks, meaning that rate differentials have widened in the greenback’s favour, helping to push the loonie through technical resistance to the downside. We believe this process could have further to go in the near term as the US economy outperforms expectations, but think cross-currency rate differentials could begin tilting in Canada’s favour by the early new year, driving a bifurcated dynamic in foreign exchange rates: a weaker loonie in the near term, followed by strength over a six-to-12 month horizon*.

*However, as they say, God invented economists to make weather forecasters look good, and then invented currency strategists to make the economists look good. Foreign exchange movements are impossible to predict with any degree of precision. As such, for most corporates and large organisations, a strategy that employs rolling, layered hedges will outperform a forecast-driven approach over the long run.

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