Foreign Exchange Commentary

Summary

• Retail sales increased in June
• Jobless claims were 221,000 in June – a decrease of 7000, the fifth consecutive weekly decline
• CPI YoY came at 2.7% - higher than the 2.6% market expectation
• PPI YoY came at 2.3% - lower than the 2.5% market forecast
• Fed Governor C. Waller called for 0.25% rate cut in July during a speech this week, changing his previous policy stance
• There were rumors on Thursday about the imminent firing of Fed Chair Jay Powell
• The U.S. dollar rallied 0.6% this week amid substantial volatility
• The Euro declined 0.23%
• The Canadian dollar dropped 0.5%
• The Mexican peso depreciated 0.25%     

Consumer Resilience Despite Inflationary Pressures

Despite ongoing price pressures, consumer spending continued to be strong in June. Retail sales increased by 0.6% month-over-month, surpassing economists’ forecasts and showing a robust recovery following declines in the previous two months.

Sales in a category excluding gasoline, autos, and restaurants, increased by 0.5% from the previous month, indicating that consumers continue to spend on discretionary goods. June’s strong spending figure is significant given the ongoing challenges of higher prices and interest rates since the pandemic.

The strength observed in June’s retail sales likely reflects several factors: sustained employment growth supporting incomes, possible front-loading of purchases ahead of further expected tariff increases, and a delayed response by consumers to rising prices.

Strength in the Labor Market Continues

In the labor market front, employment continues to demonstrate remarkable strength, with initial jobless claims declining for the fifth consecutive week to 221,000 for the week ending July 12. This represents a decrease of 7,000 from the previous week, beating market expectations of 233,000 applications. The reading marks the lowest level since mid-April, reinforcing the narrative of a stable employment environment despite broader economic uncertainties.

Continuing claims remained relatively stable at 1.96 million, suggesting that while new layoffs remain contained, the duration of unemployment for those seeking benefits has not materially improved. This stability in continuing claims, combined with the consistent decline in initial filings, points to a labor market that is neither rapidly tightening nor showing signs of significant deterioration.

The employment data's strength is particularly important given the broader economic headwinds from trade policy uncertainty. This resilience should provide the Federal Reserve with flexibility to continue its data-dependent approach.

Mixed Inflation Signals: Consumer vs. Producer Dynamics

The inflation landscape presents divergent trends between consumer and producer prices. Consumer price inflation accelerated to 2.7% year-over-year in June, marking the highest increase in four months and representing a notable surge as President Trump's tariff policies began. This inflation acceleration is directly attributable to trade policy implementation, with most imported goods now subject to minimum 10% tariffs, while steel, aluminum, automotive products, and components face separate levies starting at 25%.

However, producer price data shows a different scenario. The producer price index was unchanged from a month earlier in June. On a year-over-year basis, the headline PPI was up 2.3%, compared with 2.7% in May the lowest level since September 2024. The core PPI was at 2.6% on an annual basis, the smallest gain since July 2024.

The divergence between consumer and producer price trends suggests that while tariffs are beginning to impact retail prices, upstream inflationary pressures remain relatively contained.

Fed Policy Pivot: Waller's Dovish Shift

The week's most significant policy development came from Fed Governor Christopher Waller's unexpected advocacy for immediate rate cuts. Waller, typically among the more hawkish Fed officials, called for a quarter-point rate cut this month, citing concerns about labor market weakness and noting that “inflation remains near target with limited upside risks to price rises”

Waller's position represents a notable departure from the Fed's recent cautious approach and marks him as the most influential Fed official yet to advocate for cuts that financial markets largely expect to materialize in the fall. His emphasis on preemptive action to support employment conditions suggests growing concern within the Fed about labor market risks, despite current strength in employment indicators.

Political Pressure on Fed Independence: Powell Firing Rumors

Adding complexity to the monetary policy landscape, speculation increased this week regarding potential changes to Fed leadership. Treasury Secretary Scott Bessent confirmed that a "formal process" for replacing Jerome Powell is already underway, suggesting that Powell should step down from the central bank's board when his term as chair expires in May 2026.

The political pressure on Powell has escalated, with President Trump publicly demanding that Powell "resign immediately," calling him "very bad for the country" and criticizing him for not cutting interest rates as aggressively as Trump desires. However, Trump later denied the rumors stating it was "highly unlikely" he would fire Powell after financial media suggested the dismissal was imminent.

Any attempt to remove Powell could trigger substantial market volatility (as it did this week) and undermine confidence in central bank independence.

Policy Implications and Market Outlook

The divergence between consumer and producer price trends, combined with strong but potentially peaking consumer spending, points to an economy approaching an inflection point. June's retail sales strength may represent a final surge before tariff impacts begin to meaningfully constrain consumer behavior, as evidenced by early July softening indicators. This dynamic will provide a narrow window for the Fed to act before economic conditions start to deteriorate.

Currencies this week:

As of the time of this writing, the U.S. dollar index (DXY) is up 0.6% on the week to 98.487, following a 0.91% gain last week. Despite recent gains, the dollar index remains down 9.15% year-to-date, after a sharp selloff in March and April triggered by Trump’s unpredictable trade policies, which hurt confidence in U.S. assets.

The euro rose 0.23% to $1.1624, and the pound edged up to $1.343, but both are set for weekly declines due to strong U.S. economic data, which has reduced expectations for near-term Fed rate cuts.

In Japan, core inflation slowed in June but stayed above the Bank of Japan’s 2% target. Inflation concerns have weighed on Prime Minister Ishiba's approval ratings ahead of Sunday’s upper house election, increasing political uncertainty and weakening the yen. second straight weekly dollar gain

The Canadian dollar reached a three-week low against the U.S. dollar on Thursday, following U.S. economic data that affected currency movements. USDCAD was trading 0.5% lower at 1.3750 per U.S. dollar, or 72.73 U.S. cents, after reaching its lowest intraday level since June 23 at 1.3774.

The Mexican peso fell below 18.70 per USD to a July low after nearing a one-year high, as President Trump’s threat of new tariffs on Mexican and EU goods renewed concerns that Mexico’s export-driven economy could be hurt by trade barriers.