Foreign Exchange Commentary

Summary

• Economic environment relatively stable in the U.S but with mixed signals
• Q1 GDP revised last week to -0.5% - a larger than expected contraction
• Europe Inflation figures came in line with ECB target at 2%
• ECB is expected to hold rate steady during its July 3^rd meeting.
• Recent strong rally in EUR creating disinflation risk for the E.U - Inflation may be below the 2% target in coming months
• The Pound dropped more than 1% intraday today on headlines that Chancellor of the Exchequer Reeves may not continue - These created doubts about the British Government commitment to fiscal discipline

United States - Economic Landscape and the Dollar
In recent weeks we have seen relatively stable economic conditions in the United States despite the uncertainty around the unpredictable situation of the U.S. trade policy. At the moment we have little clarity around the short-term outcome the Trump administration is seeking from trade negotiations, and whether we will have favorable trade deals by July 9th deadline.

So far this year, economic data has been showing mixed signals with somewhat negative data points in GDP growth, retail sales and most recently inflation. 

US GDP for Q1 was revised to -0.5% last week, which was a larger than expected contraction. But this number can be attributed to businesses frontrunning tariffs in the first quarter to avoid higher costs. In fact, in Q1 we saw the U.S. current account deficit widened by $138.2 billion, or 44.3%, to $450.2 billion. If the trade balance normalizes in Q2 is likely we will see GDP growth closer to 2.5%.

Consumer spending, on the other hand, may be weakening as retail sales have decrease for two months in a row, with reductions of  0.1% in April and 0.9% in May. Although the drop in sales in not substantial, if the trend continues it may point to weaker consumer demand that could further impact economic growth momentum. This development suggests households may be pulling back on discretionary spending amid economic uncertainty.

In the labor market, employment conditions seem to be stable with nonfarm payrolls increasing more than market expectations in April and May, while the unemployment rate has been flat at 4.2% since March. 

On the inflation front, the month of May showed an uptick in the PCE inflation rate with a reading of 2.7% YoY versus a 2.5% in April and a market expectation of 2.6%.   

None of the relevant economic releases seem to be showing red flags yet. But the market continues in waiting mode, to see what the result of the trade negotiations will be on July 9th. Despite near-term challenges, some forecasts we have seen project real GDP growth of 2.9% for 2025 and 3.2% for 2026, but the scenarios assume tariff threats are just a negotiation tool for the Trump administration, and ultimately trade barriers will be reduced. 

It is also important to highlight that, despite trade tensions North American regional economic integration continues to support growth, and investment in technology sectors, particularly semiconductors and artificial intelligence infrastructure, remains strong.

Europe - Inflation, Economic Landscape and the Euro
This week Eurostat published June CPI figures for the Eurozone. The YoY estimate came at 2%, right in line with the ECB target. This probably means the central bank will leave rates at current levels in next meeting on July 3rd. 

The European economy continues to face modest growth, the European Commission is currently projecting real GDP growth of 1.1% for the EU and 0.9% for the eurozone in 2025. These figures represent similar rates to those achieved in 2024, indicating a persistent low-growth environment.

The European Central Bank has taken action to support economic growth, embarking on an easing cycle that started a year ago, cutting its benchmark rate by 225 basis points from 4.5% in June 2024 to 2.15% in June 2025. ECB President Christine Lagarde has emphasized that "downside risks to economic growth have recently increased," citing the escalation in global trade tensions and associated uncertainties as likely to impact eurozone growth going forward. Growth is expected to slow in Q2 and Q3 2025 as the unwinding of frontloaded exports in Q1 is compounded by new tariffs and trade policy uncertainty.

Headline inflation is projected to average 2.0% in 2025, 1.6% in 2026, and 2.0% in 2027. The inflation outlook faces unusual uncertainty, with global trade frictions creating both upside and downside risks. The chances of below-target inflation in Europe are rising as wage growth and services inflation decline.

The eurozone’s has made progress on inflation while facing ongoing economic fragility. The ECB appears comfortable with its current stance, signaling a pause while remaining cautious. Against this background, the euro continues to benefit from U.S. dollar weakness. As of the time of this writing, the Euro is trading at 1.1787 which is 13.95% appreciation versus the U.S. dollar since the beginning of the year. Is worth noting that this appreciation may pose risks for the E.U. In fact, some ECB officials currently argue that if the euro continues climbing past 1.20, such strength could lead to disinflationary pressure and lower growth.

The United Kingdom and the Pound  
Today we saw a drastic 1.23% percent drop in the pound, reaching an intraday low of 1.3564, on the back of headlines related to a possible exit of Chancellor of the Exchequer Rachel Reeves.  The news  rattled the market and created nervousness among investors on speculations that the new Chancellor may not stick to the fiscal rules established by the British government. The selloff was ignited when Prime Minister Keir Starmer did not confirm Reeves as part of his staff for the next general election.