24/08/2025 Week Ahead

Dollar Drops as Powell Shifts Balance of Risks

Key Takeaways:

  • Powell signaled rising downside risks to employment and hinted policy may need to adjust.
  • US assets rallied and the dollar sold off sharply.
  • Forecasts suggest another weak jobs report in early September.
  • Policy divergence between the Fed and other G10 central banks is set to widen.
  • Threats to Fed independence remain a market concern.

Markets entered last week leaning in the wrong direction. Expectations that Chair Powell would resist speculation of a September rate cut had supported the US dollar and short-term rates, while US equities endured a five-day losing streak through August 21. Instead, Powell struck a different tone. He acknowledged that downside risks to employment are rising and that the shifting balance of risks may warrant adjusting policy. The reaction was swift, with US assets rallying and the dollar falling across the board.

Attention now shifts to the upcoming US employment report due September 5. Early forecasts point to another weak outcome, with payrolls expected to rise by only 83k after July’s 73k, and the unemployment rate seen edging up to 4.3% from 4.2%. Such figures would reinforce Powell’s remarks and strengthen expectations of an earlier policy shift.

As August closes and the US heads into a holiday weekend, high-frequency data is unlikely to change the broader policy narrative. Price action itself tells the story: the dollar remains highly sensitive to interest rate expectations, and with US policy rates expected to move lower, the dollar’s support is weakening. The divergence between the Federal Reserve and other G10 central banks, except Japan, appears set to widen further against the dollar.

Meanwhile, political developments add another layer of uncertainty. President Trump’s threat to remove Governor Cook was seen as an encroachment on the Fed’s independence, a sensitive issue for markets. Governor Waller’s defense of the Fed’s independence may weaken his own prospects of becoming chair, while Powell’s likelihood of remaining on the board after his term as chair ends in 2026 appears to have strengthened.

United States of America

Overview

The US dollar’s path in recent months has been driven largely by interest rate expectations and the Federal Reserve’s policy outlook. After a steady decline in the first half of the year, the dollar staged a recovery in July, supported by a rise in Treasury yields and firming expectations for higher rates. However, August has seen a partial reversal, with yields slipping and the dollar losing momentum following Powell’s remarks at Jackson Hole. The Fed Chair acknowledged that the balance of risks is shifting, with downside risks to employment now more prominent, reinforcing expectations that policy easing could be brought forward.

The flow of economic data remains steady, but few reports are expected to meaningfully alter the market’s conviction that the Fed will gradually unwind its restrictive stance. Despite some weakness in manufacturing, including falling Boeing orders and soft core capital goods, household income and consumption trends remain firm, although inflation-adjusted spending has been flat in the first half of the year. Meanwhile, inflation pressures are still evident, with the PCE deflator expected to show continued progress toward the Fed’s target range.

Economic Drivers

  • US interest rate dynamics remain the key driver, with 10-year Treasury yields rising nearly 15 bp in July before easing by about 12 bp in August.
  • Two-year yields rose almost 24 bp in July but have fallen about 25 bp this month, highlighting shifting Fed expectations.
  • The implied year-end effective Fed funds rate rose 33 bp in July and is about 22 bp lower so far in August.
  • Powell’s Jackson Hole remarks underscored rising downside risks to employment and suggested policy adjustments may be warranted.
  • Weakness in durable goods and capital investment, driven by declining Boeing orders, highlights pockets of economic fragility.
  • Personal income and nominal consumption remain firm, though real personal consumption expenditures were flat in H1.
  • Inflation pressures persist, with PCE deflators expected to rise 0.3% month-on-month, lifting headline rates toward 2.7%-2.8% and core rates toward 2.9%-3.0%.

Data and Events

  1. 25 August 2025: New Home Sales
  2. 26 August 2025: Durable Goods Orders
  3. 26 August 2025: CB Consumer Confidence
  4. 26 August 2025: Richmond Manufacturing Index
  5. 28 August 2025: Prelim GDP
  6. 28 August 2025: Unemployment Claims
  7. 29 August 2025: FOMC Member Speaks
  8. 29 August 2025: Core PCE Price Index

Price Action

  • After weakening through the first half of the year, the dollar rebounded in July alongside firmer Treasury yields.
  • Early August saw a partial pullback, though last week’s trading was supported until Powell’s remarks.
  • The high near 98.85 ahead of the weekend reversed sharply, producing a bearish outside down day.
  • A break below 97.80 may signal risk of a deeper pullback toward the July 1 low near 96.40.

Key Points:

  • US interest rate shifts remain the dominant driver of the dollar.
  • Powell highlighted rising downside risks to employment.
  • Durable goods and capital investment are under pressure, led by falling Boeing orders.
  • Inflation pressures remain, with PCE deflators moving toward 3%.
  • Technical signals warn of potential renewed dollar weakness.

Australia & New Zealand

Overview

The Australian dollar has been highly sensitive to shifts in global risk sentiment and US dollar movements. Correlations between the Australian dollar and the Dollar Index have reached their most extreme levels in a year, underscoring the currency’s vulnerability to broader dollar swings. The relationship with the Canadian dollar has also tightened, with both currencies moving almost in lockstep against the US dollar.

Attention this week is focused on the Reserve Bank of Australia’s policy meeting record following its recent quarter-point rate cut. Markets are assessing whether policymakers are preparing to move again at the next meeting or later this year. Futures pricing indicates a roughly 1-in-3 chance of another cut in September, with a further reduction fully priced by year-end. This would bring the cash target rate slightly below 3.0% compared to the current 3.6%, marking the projected terminal rate.

Economic Drivers

  • Strong inverse correlation with the US dollar, with a 30-day correlation above -0.80, the most extreme in a year.
  • Correlation with the Canadian dollar also near -0.80, reflecting similar pressures from global dollar moves.
  • Market expectations for further rate cuts remain firm, with futures projecting a terminal rate slightly below 3.0%.
  • The central bank’s recent quarter-point rate cut has shifted focus toward the likelihood of additional easing.

Data and Events

  1. 25 August 2025: Retail Sales (NZD)
  2. 26 August 2025: Monetary Policy Meeting Minutes
  3. 27 August 2025: CPI

Price Action

  • The Australian dollar fell to a monthly low near $0.6415 before recovering on Powell’s remarks.
  • The rebound lifted the currency briefly above $0.6500, retracing more than half of its August losses.
  • Key retracement levels stand at $0.6510 (61.8% of recent decline), $0.6520 (50% of July high decline), and $0.6545 (61.8% of July high decline).

Key Points:

  • Australian dollar highly correlated with both US dollar and Canadian dollar.
  • RBA minutes in focus after recent quarter-point rate cut.
  • Markets see at least one more rate cut before year-end.
  • AUD/USD rebounded sharply after Powell’s comments.

Canada

Overview

The Canadian dollar has remained closely tied to the broader direction of the US dollar, with correlations to the Dollar Index remaining elevated. Over the past 30 sessions, the correlation has been slightly above 0.75, highlighting its strong link to US dollar moves. Earlier this year, the relationship was much weaker, underscoring how global dollar flows now dominate trading in the Canadian dollar. At the same time, the currency’s traditional link to risk appetite through equities has weakened. While the Canadian dollar was once highly sensitive to changes in the S&P 500, this relationship has diminished, with the 100-day rolling correlation at its least inverse level since early 2018.

Economic data suggests a slowdown in Canada’s growth momentum. GDP contracted by 0.1% in both April and May following modest gains in Q1. June is expected to show only a slight expansion of 0.1%, while projections for Q2 point to a small contraction of 0.3%-0.5% on an annualized basis, compared with 2.2% growth in Q1. The outlook for Q3 is slightly better, though only marginally above stagnation.

Economic Drivers

  • Canadian dollar strongly correlated with the US dollar, with a 30-day correlation above 0.75.
  • The correlation to the S&P 500 has weakened significantly, reducing its sensitivity to shifts in global risk appetite.
  • Canadian GDP contracted by 0.1% in April and May, with June expected to post only a modest gain of 0.1%.
  • Q2 GDP is projected to contract by 0.3%-0.5% after 2.2% growth in Q1, highlighting slowing momentum.
  • Q3 economic performance expected to improve slightly, but still hover near stagnation.

Data and Events

  1. 27 August 2025: BOC Gov Macklem Speaks
  2. 28 August 2025: Current Account
  3. 29 August 2025: GDP

Price Action

  • The Canadian dollar weakened to three-month lows despite stronger-than-expected retail sales.
  • US dollar lows were set in mid-June near CAD1.3540, followed by higher lows in July.
  • The US dollar broke above CAD1.3900 last week, reaching CAD1.3925 before reversing lower on Powell’s remarks.
  • Despite the dollar’s broad decline after Powell’s comments, the Canadian dollar under-performed, gaining only 0.70% against the US dollar, the weakest among G10 currencies.

Key Points:

  • Canadian dollar closely tied to US dollar direction, with correlation above 0.75.
  • Sensitivity to equity markets has weakened, limiting risk-driven moves.
  • GDP contracted in April and May, with Q2 set to show a small annualized decline.
  • Despite strong retail sales, CAD under-performed in a weaker US dollar environment.
  • US dollar strength above CAD1.3900 highlights continued pressure on the Canadian dollar.

China

Overview

Chinese officials remain committed to maintaining broad stability in the yuan against the US dollar, tolerating only minor appreciation. While some foreign observers argue that China’s large trade surplus justifies a revaluation, the relationship between trade balances and exchange rates is more complex. For example, Japan runs a trade deficit yet has an undervalued yen, while Switzerland’s franc is overvalued despite strong trade surpluses. In China’s case, deflationary pressures persist, making currency appreciation inconsistent with traditional policy prescriptions, as it would tighten financial conditions further.

The yuan’s behavior reflects close management rather than a free response to data or market forces. Industrial profits have become an area of concern, falling by 4.3% year-on-year in June, reversing the modest gain reported in 2024. The decline highlights structural issues tied to over-investment and competitive pressures that suppress profitability. In response, Beijing has moved to address excessive capacity and encourage a more balanced industrial landscape.

Economic Drivers

  • Authorities determined to maintain yuan stability, tolerating limited appreciation.
  • Large trade surplus not automatically driving currency revaluation due to complex trade-FX dynamics.
  • Deflationary forces discourage currency strength, as appreciation would tighten financial conditions.
  • Industrial profits fell 4.3% year-on-year in June, reflecting over-investment and margin pressures.
  • Government campaign launched to address excess capacity and improve profitability.

Data and Events

  1. 27 August 2025: CB Leading Index

Price Action

  • The US dollar bottomed slightly below CNY7.15 a month ago.
  • Dollar fell to CNY7.1635 before the weekend, marking a new monthly low.
  • Offshore yuan closed near CNH7.1715, the weakest dollar close in almost a month.
  • Gradual lowering of the daily reference rate by the PBOC has not triggered sustained US dollar declines.

Key Points:

  • Authorities prioritise yuan stability with limited appreciation allowed.
  • Trade surplus alone not dictating FX policy due to broader structural factors.
  • Deflationary conditions weigh against currency strength.
  • Industrial profits remain under pressure, prompting government intervention.
  • Yuan trading remains tightly managed despite reference rate adjustments.

Europe

Overview

The euro continues to benefit from its position as a liquid and deep alternative to the US dollar. Interest rate dynamics are also turning more supportive. The discount for holding euros relative to US two-year yields has narrowed as markets have become more dovish on the Federal Reserve while scaling back expectations of European Central Bank easing. Overnight swaps now project the year-end deposit rate near 1.85%, the highest since the end of Q1, reinforcing the euro’s appeal.

On the data front, eurozone releases remain limited, with lending and monetary aggregates offering only modest policy signals. Inflation expectations remain stable, with the ECB’s one-year projection at 2.6% in June and longer-term expectations at 2.4%. Eurozone CPI rose 2.0% year-over-year in July, broadly consistent with the ECB’s target and keeping the focus on the pace of future policy adjustments.

Economic Drivers

  • Euro supported by its depth and liquidity as an alternative to the US dollar.
  • Narrowing of the two-year interest rate discount adds to euro’s strength.
  • Markets have grown more dovish on the Fed while trimming expectations of ECB easing.
  • Year-end deposit rate projected near 1.85%, the highest since end of Q1.
  • ECB inflation expectations stable at 2.6% (one-year) and 2.4% (three-year).
  • Eurozone CPI rose 2.0% year-over-year in July.

Data and Events

  1. 25 August 2025: German ifo Business Climate
  2. 28 August 2025: ECB Monetary Policy Meeting Minutes
  3. 29 August 2025: German Retail Sales
  4. 29 August 2025: German Prelim CPI
  5. 29 August 2025: German Unemployment Change

Price Action

  • After dipping below $1.14 in July, the euro recovered in early August to $1.1730 by mid-month.
  • Stronger US rates pulled it lower, breaking through the $1.1600 retracement level and reaching $1.1585 before Powell’s remarks.
  • Powell’s dovish signal triggered a sharp rebound, sending the euro to a new monthly high above $1.1740.
  • The bullish outside up day confirmed momentum, with resistance seen at $1.1800-30 and a longer-term target at $1.20 before year-end.

Key Points:

  • Euro supported by narrowing rate differentials with the US.
  • Markets expect the ECB to remain cautious with limited easing ahead.
  • Inflation expectations remain stable near target.
  • Euro surged to new highs after Powell’s comments on rates.
  • Upside momentum leaves $1.20 as a realistic target before year-end.

Japan

Overview

The yen continues to be driven primarily by shifts in US interest rates, with correlations to US yields far stronger than those to Japanese government bonds. Over the past 30 days, the correlation between the yen and US two-year yields has been around 0.80, while the link to Japanese two-year yields has been negligible. Similar dynamics are observed with longer-term rates, with the yen’s moves closely aligned to the 10-year US Treasury yield, but inversely correlated to the 10-year JGB. This reinforces that external drivers remain the dominant influence on the yen.

Japan’s domestic economic picture has shown some resilience. Q2 GDP surprised to the upside, growing 1.0% annualized, while Q1 GDP was revised higher to 0.6% from an initial contraction. Still, the outlook for Q3 will depend on upcoming data. Industrial production may have softened, though retail sales remain firm. More critical for the Bank of Japan will be the Tokyo CPI, which provides an early signal for nationwide inflation. Expectations point to some moderation across key measures. Markets are already pricing in the possibility of BoJ tightening later this year, with about 20 bp of hikes projected and a 50% chance of a move in October, rising to nearly 80% before year-end.

Economic Drivers

  • Yen highly sensitive to US rates, with 30-day correlation to US two-year yields around 0.80.
  • Weak correlation with Japanese yields, highlighting domestic rates as a limited driver.
  • Q2 GDP expanded by 1.0% annualized, Q1 revised to 0.6% from -0.2%.
  • Retail sales appear firm, while industrial production may have contracted.
  • Tokyo CPI expected to soften, providing key signals for BoJ policy direction.
  • Swaps market pricing suggests about 20 bp of tightening this year, with 50% chance of an October hike and nearly 80% chance by year-end.

Data and Events

  1. 26 August 2025: BOJ Core CPI
  2. 29 August 2025: Tokyo Core CPI
  3. 29 August 2025: Unemployment Rate
  4. 29 August 2025: Retail Sales
  5. 29 August 2025: Consumer Confidence
  6. 29 August 2025: Housing Starts

Price Action

  • Dollar rose to JPY148.80 last week, the highest since August 1, surpassing the 50% retracement of the month’s losses near JPY148.55.
  • Powell’s dovish remarks drove US yields lower, pushing the dollar down to JPY146.60, the lowest since July 23.
  • Support lies near JPY146, a level not broken since July 4.
  • Trendline support from April and July lows sits near JPY144.85 at the start of the week and rises toward JPY145.10 by week’s end.

Key Points:

  • Yen remains tightly linked to US rate movements.
  • Domestic GDP stronger than expected, with Q2 growth at 1.0%.
  • Tokyo CPI expected to soften, guiding BoJ expectations.
  • Market pricing leans toward a BoJ hike by year-end.
  • Dollar-yen faces critical support levels around JPY146 and below.

United Kingdom

Overview

Sterling remains highly influenced by the broader direction of the US dollar, with correlations underscoring its sensitivity to global moves rather than domestic developments. The 30-day correlation between changes in sterling and the Dollar Index stands near 0.80, while the correlation with the euro is slightly lower at 0.76. Sterling’s exchange rate is more closely aligned with US interest rates than with UK rates, highlighting how external drivers continue to outweigh domestic monetary signals.

This week offers little in the way of UK economic data that could meaningfully shift sentiment. Retail-related reports such as the BRC shop price index and the CBI retail survey typically have limited market impact, leaving sterling to trade mainly on global factors, particularly US dollar movements and interest rate expectations.

Economic Drivers

  • Sterling’s correlation with the Dollar Index is near 0.80, showing strong sensitivity to broad dollar trends.
  • Correlation with the euro is slightly lower at 0.76.
  • Exchange rate more sensitive to US interest rates than UK rates, with 30-day correlation to US two-year yield near -0.50.
  • Correlation with two-year Gilt yields is barely positive, while the two-year UK-US yield differential correlation is around -0.25.
  • Domestic data has little influence this week, leaving global dollar dynamics as the main driver.

Data and Events

No major economic releases are scheduled this week.

Price Action

  • Sterling overshot the 61.8% retracement of July’s decline, reaching almost $1.3600 on August 14.
  • It then dropped toward $1.3390 before Powell’s comments triggered a sharp rebound.
  • The currency rallied to nearly $1.3545, close to the weekly high set slightly above $1.3565.
  • Sterling looks positioned to re-test $1.3600, with potential to extend gains toward $1.3790 and possibly $1.40 in the coming months.

Key Points:

  • Sterling strongly tied to global dollar direction, with correlations near 0.80.
  • Domestic rate dynamics remain secondary to US yield movements.
  • Limited UK data this week offers little scope for independent moves.
  • Technical outlook points to a retest of $1.3600 with upside potential beyond.
  • Broader trajectory depends on dollar shifts and global rate expectations.

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