31/08/2025 Week Ahead

Fed Prepares for Measured Cuts Amid Shifting Dynamics

Key Takeaways:

  • The Fed is expected to cut rates by 25 bps in September, not 50 bps.
  • Dollar strength is likely to ease but not collapse.
  • Legal battles challenge presidential powers under IEEPA and Fed independence.
  • Washington prepares targeted tariffs on key industries.
  • China faces property weakness, structural over-investment, and yuan policy shifts.
  • Global markets are shaped by the fusion of monetary policy, trade, law, and geopolitics.

The Federal Reserve is preparing to resume rate cuts in September, with expectations settled on a 25 bps reduction after stronger retail sales, firm producer prices, and sticky core inflation dampened speculation of a larger move. Policymakers continue to frame rates as restrictive, which means this adjustment will be presented as a fine-tuning of policy, not as the start of a broad easing cycle.

The divergence between the Fed and other central banks is beginning to narrow. Most G10 and many emerging market peers have already eased this year, leaving the dollar vulnerable to smaller interest rate differentials. Still, this is not the start of a weak-dollar era. The greenback, though rich by most measures, is shifting from expensive to less expensive, not to undervalued.

Political and legal risks are also in focus. A federal appeals court ruled that President Trump exceeded his authority under the International Emergency Economic Powers Act, raising the prospect of Supreme Court involvement. At the same time, the administration is preparing new tariffs targeting critical sectors such as semiconductors, pharmaceuticals, and rare earths. Parallel legal challenges question the Fed’s independence, as lawsuits attempt to test whether the executive branch can fire sitting governors.

China remains central to the global narrative. Property sector weakness persists despite state interventions, and Beijing is weighing pressure on state entities to absorb unsold homes. The debate over under-consumption has given way to a stronger argument that the country suffers from over-investment, with local governments and state-owned banks fueling industrial excess. Beijing’s “involution” campaign aims to curb this pattern and rebalance growth.

Currency policy also reflects this tension. The yuan, undervalued by 10–20% on many models, remains tied closely to the dollar. Officials are allowing slightly greater daily flexibility, with the central bank guiding the currency lower since May, but volatility is subdued compared to earlier this year. The yuan’s path is shaped as much by dollar strength as by domestic fundamentals, and Beijing continues to reject Washington’s push for currency coordination.

As the quarter closes, four themes dominate: the Fed’s measured pivot, Washington’s tests of executive authority, China’s structural imbalances, and the dollar’s gradual adjustment. Each issue is significant on its own, but together they highlight the growing overlap of economics, law, and geopolitics. Markets are navigating not clarity but complexity.

United States of America

Overview

The Federal Reserve is preparing to cut rates for the first time this year, reflecting a shift in its risk assessment due to the weakening labor market. Alongside the policy move, the Fed will release updated economic projections. In June, the median forecast suggested three cuts in 2026, but expectations are shifting toward four. The central bank may also announce a slowdown in balance sheet reduction as reserves fall toward levels that risk tightening liquidity. Since April 2022, the Fed’s balance sheet has already been reduced by more than 25%.

The economic calendar will be eventful, with a soft employment report anticipated in early September, followed by significant downward revisions to nonfarm payrolls. Inflation is also likely to tick higher in the coming months as tariff increases filter through to consumers. Additional sector-specific tariffs on pharmaceuticals and semiconductors are expected, while investigations into furniture trade point to more protectionist measures by year-end.

Political and legal risks are also gathering momentum. Lawsuits targeting the Fed’s independence, such as those involving Governor Cook, highlight tensions between the executive branch and the central bank. Legal challenges to the administration’s use of emergency powers for tariffs continue to move through the courts and are expected to reach the Supreme Court. Despite market talk of capital flight, foreign demand for U.S. assets remains strong. The Treasury’s International Capital report shows nearly $768 billion in net foreign purchases in the first half of 2025, exceeding totals for the same period in the past two years combined.

Economic Drivers

  • Labor market deterioration prompting a Fed rate cut.
  • Revised Summary of Economic Projections, likely increasing 2026 cuts from three to four.
  • Slowing of quantitative tightening as reserves near critical levels.
  • Inflation pressures rising as tariffs pass through to consumers.
  • Trade investigations targeting pharmaceuticals, semiconductors, and furniture.
  • Political pressure on the Fed, with legal cases challenging its independence.
  • Ongoing legal disputes over presidential powers to levy tariffs.
  • Strong foreign inflows into U.S. financial assets despite market speculation of divestment.

Data and Events

  1. 02 September 2025: ISM Manufacturing PMI
  2. 03 September 2025: JOLTS Job Openings
  3. 04 September 2025: Beige Book
  4. 04 September 2025: ADP Non-Farm Employment Change
  5. 04 September 2025: Unemployment Claims
  6. 04 September 2025: ISM Services PMI
  7. 05 September 2025: Average Hourly Earnings
  8. 05 September 2025: Non-Farm Employment Change
  9. 05 September 2025: Unemployment Rate

Price Action

  • Dollar strength tempered by expectations of Fed cuts and narrowing rate differentials.
  • Treasury yields sensitive to labor market weakness and revised Fed projections.
  • Equity markets balancing tariff-driven inflation risks against anticipated Fed easing.

Key Points:

  • Fed expected to cut rates in September, first move this year.
  • QT may slow or end as reserves approach critical levels.
  • Tariffs on key sectors will raise inflation pressures.
  • Political and legal disputes challenge Fed independence and presidential authority.
  • Foreign demand for U.S. assets remains strong, countering divestment concerns.

Australia

Overview

The Reserve Bank of Australia cut its cash rate for the third time this year in August, lowering it to 3.60%. Policymakers signaled scope for continued gradual easing, but the language suggests that cuts will not occur at consecutive meetings. With three policy meetings remaining in 2025, futures markets are pricing in around 30–35 bps of additional easing, with the terminal rate projected near 3% in 2026.

Australia’s trade relationship with the United States remains under pressure. Although the free-trade agreement that has been in place since 2005 prevents new reciprocal tariffs, it has not shielded Australian exports from the 10% levy imposed by Washington. Exposure to targeted tariffs remains a risk for Australian goods. Beyond trade, geopolitical uncertainty surrounds the AUKUS nuclear submarine deal. Reports from Washington highlight U.S. and U.K. production constraints, raising the possibility of significant delays or even policy reversals. U.S. defense officials, including Under Secretary of Defense Elbridge Colby, have previously underscored that submarine capacity is already stretched.

The Australian dollar reached its yearly high near $0.6625 in late July, and market expectations suggest this level could be tested again in the coming weeks. Some analysts see potential for further upside toward $0.6700 by the end of the quarter, supported by monetary policy easing and relative demand for the currency.

Economic Drivers

  • RBA cut rates to 3.60% in August, signaling scope for further gradual easing.
  • Futures market pricing in 30–35 bps of additional cuts this year, terminal rate seen near 3% in 2026.
  • U.S.–Australia free-trade agreement limits reciprocal tariffs but does not prevent existing levies.
  • Ongoing U.S. 10% tariff on Australian exports and risk of sectoral tariffs.
  • Geopolitical risk from uncertainty around the AUKUS nuclear submarine deal due to U.S. and U.K. capacity constraints.

Data and Events

  1. 01 September 2025: MI Inflation Gauge
  2. 02 September 2025: Current Account
  3. 03 September 2025: GDP
  4. 03 September 2025: RBA Gov Bullock Speak
  5. 04 September 2025: Goods Trade Balance

Price Action

  • Australian dollar peaked at $0.6625 in late July, yearly high.
  • Potential to retest highs in coming weeks.
  • Upside target toward $0.6700 by the end of the quarter.

Key Points:

  • RBA has cut rates three times this year, policy rate now at 3.60%.
  • Market expects further easing, with terminal rate near 3% in 2026.
  • U.S. tariffs continue to weigh on Australian exports.
  • AUKUS submarine deal faces risks from U.S. production constraints.
  • Australian dollar showing resilience, with scope for further gains.

Canada

Overview

The Canadian dollar’s performance continues to mirror broad moves in the U.S. dollar. When the greenback strengthens, the Canadian dollar tends to hold up better than most peers, and when it weakens, the Canadian dollar lags. In July, the Canadian dollar lost 1.8% against the U.S. dollar, the smallest decline among G10 currencies. In contrast, during the first half of 2025 when the dollar trended lower, the Canadian dollar gained 5.7%, the weakest advance among major peers.

In August, the dollar softened, but the Canadian dollar only outperformed the New Zealand dollar, which had been pressured by its central bank’s dovish policy move. The Bank of Canada now faces increased pressure to ease following a weak second-quarter GDP report. The economy contracted by 1.6% on an annualized basis, more than double the expected decline, while Q1 growth was revised lower to 2.0% from 2.2%. This deterioration has lifted market expectations for a September rate cut, with the probability climbing to just above 55% from 25% at the start of August.

While only about a 40% chance of one final cut in the cycle is currently priced in, the weakening U.S. economy and the likelihood of further Federal Reserve easing could provide the Bank of Canada additional space to act. Market focus will be on the upcoming September 17 policy meeting, as investors weigh the balance between domestic economic weakness and external monetary trends.

Economic Drivers

  • Canadian dollar performance linked closely to U.S. dollar trends.
  • Q2 GDP contracted by 1.6% annualized, exceeding expectations of a smaller decline.
  • Q1 GDP revised down to 2.0% from 2.2%.
  • Rising probability of a Bank of Canada rate cut in September, now above 55%.
  • Potential scope for further easing if U.S. economic weakness drives more aggressive Fed cuts.

Data and Events

  1. 02 September 2025: Manufacturing PMI
  2. 04 September 2025: Trade Balance
  3. 05 September 2025: Employment Change
  4. 05 September 2025: Unemployment Rate
  5. 05 September 2025: IVEY PMI

Price Action

  • U.S. dollar rejected from a three-month high near CAD1.3925 on 22 August.
  • Scope for USD/CAD to trend toward CAD1.3640–CAD1.3700 in the coming weeks.

Key Points:

  • Canadian dollar strength and weakness remain tied to U.S. dollar moves.
  • Weak Q2 GDP adds pressure on the Bank of Canada to ease policy.
  • Market pricing now reflects more than a 55% chance of a September cut.
  • U.S. economic softness may widen the BoC’s room to act.
  • USD/CAD faces downside potential after failing to break recent highs.

China

Overview

The Chinese yuan strengthened by around 1% against the U.S. dollar in August, bringing year-to-date gains close to 2.4%. This follows a 2.75% decline in 2024. The People’s Bank of China continues to manage the exchange rate through its daily reference rate, which has been set progressively lower and now sits at its weakest level since November of last year. At the same time, the central bank has allowed greater flexibility in daily adjustments, with the size of recent changes several times larger than earlier in the year.

Despite this, both implied and historical volatility in the yuan remain subdued. Three-month historical volatility has slipped below 1.8%, the lowest in a year, while implied volatility, though slightly higher, is also near multi-year lows. This suggests that market expectations of sharp currency swings are limited. In a strong U.S. dollar environment, the yuan has shown resilience, and as seen in July, it tends to perform better relative to peers. However, in periods of broad dollar weakness, the yuan has lagged behind.

Looking ahead, significant new policy measures are unlikely before the upcoming 4th Plenum, which is expected to focus on governance and ideological issues. Authorities may still press state-owned enterprises to play a greater role in stabilizing the property market. At the same time, Beijing’s anti-involution campaign, aimed at curbing excessive investment in certain sectors, could see further support measures to balance growth.

Economic Drivers

  • Yuan gained 1% in August, 2.4% year-to-date, after falling 2.75% in 2024.
  • PBOC guiding the market by lowering the dollar reference rate to its weakest since November 2023.
  • Greater flexibility in the daily fix, with larger adjustments than earlier in the year.
  • Historical volatility at 1.8%, lowest in a year, with implied volatility also near lows.
  • Yuan tends to lag in weak-dollar environments but can outperform when the dollar strengthens.
  • No major new policy expected ahead of the 4th Plenum, which will emphasize ideology and governance.
  • Possible measures to push state-owned firms to support property market stabilization.
  • Continuation of anti-involution campaign targeting over-investment.

Data and Events

  1. 31 August 2025: Manufacturing & Non-Manufacturing PMI
  2. 01 September 2025: Manufacturing PMI
  3. 03 September 2025: Services PMI

Price Action

  • Yuan rose 1% in August and is up 2.4% year-to-date.
  • Dollar reference rate set lower, guiding currency strength.
  • Volatility measures suggest stable trading environment.
  • Likely to underperform in weak-dollar trends, but can outperform in strong-dollar periods.

Key Points:

  • Yuan strengthened in August but remains highly sensitive to dollar trends.
  • PBOC managing reference rate lower while increasing flexibility in daily fixes.
  • Volatility at multi-year lows, pointing to controlled market conditions.
  • Policy focus shifting to property market support and curbing over-investment.
  • No major policy changes expected before the 4th Plenum.

Europe

Overview

The euro rebounded in August after briefly dipping below $1.16 at the start of the month, climbing toward $1.1715 before consolidating. The main catalyst was the broader pullback in the U.S. dollar as American yields declined. The U.S. two-year premium over Germany narrowed to below 170 bps, its smallest margin since March, easing some of the pressure on the euro.

With the European Central Bank’s deposit rate at 2.0%, the market has scaled back expectations for further policy easing this year. Current pricing implies just over a 35% probability of another cut in 2025, while the chance of one additional move in 2026 remains elevated at about 75%. Despite ongoing fiscal efforts in infrastructure and defense, eurozone growth is stagnating, with Q2 GDP at 0.1% and forecasts pointing to similar weakness in the current quarter. Inflation is expected to hover near, though mostly below, the 2% target in the coming months.

Bond spreads remain stable, reflecting reduced political tensions within the bloc. Germany’s 10-year yield premium over Italy, Spain, and Portugal is near its narrowest since 2010. Greek yields are trading below those of France, underscoring France’s status as a weak link. The French government faces a confidence vote on September 8 tied to fiscal challenges. A loss could lead President Macron to appoint a new prime minister, as calling snap elections would be seen as tantamount to his resignation given his term limits. Meanwhile, the EU has adopted a measured stance toward U.S. tariffs, prioritizing stability over confrontation.

Economic Drivers

  • Euro supported by U.S. yield declines and narrowing U.S.–German rate spreads.
  • ECB deposit rate at 2.0%, market pricing in limited easing this year and higher odds of a 2026 cut.
  • Eurozone growth stagnant at 0.1% in Q2, with little improvement expected in Q3.
  • Inflation expected to remain near but mostly below 2% in coming months.
  • Political tensions subdued, with tight bond spreads across southern Europe.
  • France remains a weak point, with government instability and a September 8 confidence vote looming.
  • EU taking low-key approach to U.S. tariffs, focusing on stability.

Data and Events

  1. 01 September 2025: Final Manufacturing PMI
  2. 01 September 2025: Unemployment Rate
  3. 02 September 2025: CPI Flash Estimate
  4. 03 September 2025: ECB President Lagarde Speaks
  5. 03 September 2025: Final Services PMI
  6. 03 September 2025: PPI
  7. 04 September 2025: Retail Sales
  8. 05 September 2025: Germany Factory Orders
  9. 05 September 2025: Revised GDP

Price Action

  • Euro recovered from lows below $1.16 to nearly $1.1715 in August.
  • U.S.–German two-year spread narrowed to below 170 bps, supporting euro stability.
  • Market consolidating gains as ECB outlook remains cautious.

Key Points:

  • Euro rebounded in August on weaker U.S. dollar and lower yields.
  • ECB unlikely to cut further this year, though 2026 cut expectations remain high.
  • Growth stuck at 0.1% with inflation near target but subdued.
  • France faces political risk from a September 8 confidence vote.
  • EU prioritizing stability in response to U.S. tariffs.

Japan

Overview

The yen remains highly sensitive to movements in U.S. interest rates. The 30-day rolling correlation between changes in the U.S. two-year yield and the dollar-yen exchange rate is around 0.80, near the strongest since mid-2023. A similar correlation with the 10-year U.S. yield, just below 0.80, is the highest level observed since late 2021. These dynamics underscore the degree to which Japanese markets remain tied to U.S. monetary developments.

Japan’s growth performance in the first half of 2025 has been stronger than expected. Q1, initially reported as a 0.2% annualized contraction, was revised to 0.6% growth, while Q2 GDP expanded by 1%, more than twice the consensus forecast. Inflation has moderated after peaking earlier in the year. Headline CPI hit 4% in January and stands at 3.1%, while core inflation reached its high of 3.7% in May before easing back to 3.1% in July. Both measures are expected to show further declines in August, signaling a cooling trend.

Monetary policy expectations remain cautious. The swaps market assigns less than a 10% probability of a rate hike in September but sees slightly above a 50% chance in October. Market participants expect the policy rate, currently at 0.50%, to eventually rise toward 1%. Currency projections suggest scope for the dollar-yen to decline in the coming weeks, with a potential move toward the JPY145.00–145.40 range.

Economic Drivers

  • Strong correlation between yen movements and U.S. rate changes, with 30-day correlations near multi-year highs.
  • Q1 GDP revised to 0.6% growth from a reported contraction, Q2 GDP expanded by 1%.
  • Inflation peaked at 4% in January, with core inflation peaking at 3.7% in May; both eased to 3.1% in July.
  • Inflation expected to moderate further in August.
  • Market pricing shows less than 10% chance of a September rate hike, slightly more than 50% chance for October.
  • Terminal rate expectations around 1%, up from the current 0.50%.

Data and Events

  1. 01 September 2025: Final Manufacturing PMI
  2. 02 September 2025: 10-y Bond Auction
  3. 04 September 2025: 30-y Bond Auction
  4. 05 September 2025: Average Cash Earnings
  5. 05 September 2025: Household Spending

Price Action

  • Yen closely tracking U.S. yields, with strong correlation to both two-year and 10-year rates.
  • Dollar-yen expected to trend lower, targeting JPY145.00–145.40 in the coming weeks.

Key Points:

  • Yen remains highly sensitive to U.S. interest rate movements.
  • Japanese GDP outperformed expectations in H1 2025.
  • Inflation peaked earlier this year and is gradually easing.
  • Market expects gradual tightening, with terminal rate near 1%.
  • Dollar-yen projected to soften toward JPY145.00–145.40.

United Kingdom

Overview

Sterling rebounded strongly in August after its first monthly decline since January. The currency fell 3.8% in July but regained 2.0% in August, recovering from a nearly four-month low around $1.3140 on August 1 to end the month just below $1.3500. The broader weakness in the U.S. dollar supported sterling, but the key driver was a reassessment of Bank of England policy expectations.

Markets are now pricing in a higher implied year-end rate, rising from around 3.65% in early August to nearly 3.90% by late month. The shift was reinforced by stronger-than-expected domestic data. UK headline CPI accelerated to 3.8% in July, the highest since January 2024, while Q2 GDP expanded 0.3% quarter-over-quarter, outperforming the Bank of England’s and private forecasts of just 0.1%. Growth was flattered by higher government consumption and investment.

Rate differentials also favored sterling. The UK two-year premium over the U.S. widened to nearly 35 bps in late August, compared with a 10 bp discount in late July. Meanwhile, the UK’s 10-year premium more than doubled in August to around 50 bps, the widest since April. Looking ahead, fiscal risks remain a concern, with the Autumn budget statement in early Q4 expected to outline the government’s stance on public finances. Market participants see sterling challenging the multi-year high of $1.3800 reached on July 1, with scope toward $1.40 before year-end if momentum continues.

Economic Drivers

  • Sterling rose 2.0% in August after a 3.8% decline in July.
  • Higher year-end Bank of England rate expectations, rising from 3.65% to 3.90%.
  • Headline CPI at 3.8% in July, highest since January 2024.
  • Q2 GDP growth of 0.3%, stronger than expected 0.1%.
  • Government consumption and investment boosted economic performance.
  • UK two-year premium over U.S. widened to 35 bps, while 10-year premium doubled to 50 bps.
  • Fiscal uncertainty tied to the Autumn budget statement in early Q4.

Data and Events

  1. 01 September 2025: Final Manufacturing PMI
  2. 03 September 2025: Final Services PMI
  3. 03 September 2025: Monetary Policy Report Hearings
  4. 04 September 2025: Construction PMI
  5. 05 September 2025: Retail Sales

Price Action

  • Sterling rebounded from $1.3140 on August 1 to finish August near $1.3500.
  • Market expects sterling to test $1.3800, the July 1 multi-year high.
  • Potential extension toward $1.40 by year-end.

Key Points:

  • Sterling rebounded in August after sharp July losses.
  • Rising UK rate expectations supported currency strength.
  • Inflation at 3.8% and GDP growth of 0.3% boosted outlook.
  • UK yield premiums over the U.S. widened significantly.
  • Sterling seen testing $1.3800 with potential toward $1.40.

SKONE Enterprise provides expert market analysis and forecasts. Our insights help traders and investors navigate the complex currency landscape.

© 2025 SKONE Enterprise (003319453-V). All rights reserved.

The content on this site is for informational purposes only and does not constitute financial advice.