US dollar sell-off extends further as bullish outlook questioned

USD: Softer US retail sales reinforce US dollar sell-off

The US dollar has continued to trade at weaker levels overnight following last week’s sell-off. The dollar index dropped sharply at the end of last week hitting a low of 106.57 on Friday recording a loss of -1.2% for the week as a whole and extending its decline to around -3.2% from the high set earlier this year on 13^th January at 110.18. The biggest beneficiaries last week amongst G10 currencies of further US dollar weakness were the European currencies of the Swedish krona (+2.4% vs. USD), euro (+1.6%) and GBP (+1.5%). In contrast the only G10 currency which failed to strengthen against the US dollar was the yen (-0.6% vs. USD). However, there has been some catch up yen strength overnight with USD/JPY falling back towards 151.50. The US dollar sell-off was reinforced at the end of last week by the release of the much softer than expected US retail sales report for January. The report revealed that control retail sales unexpectedly contracted by -0.8% in January following an increase of +0.8% in December. It was not a good start to the year for consumer spending and reflects in part payback for the strong holiday spending season. Weakness in retail sales was widespread but much of it came from categories of spending that were strong in December. The report has reinforced expectations that consumer spending growth will slow down towards 2.0% in Q1 after expanding robustly again by around 4.0% in Q4 of last year. We view this as more of a temporary setback after a robust sales at the end of last year rather than the start of a more sustained slowdown. However, it has helped to put a dampener on US yields in the near-term. The 10-year US Treasury yield fell back below 4.50% at the end of last week. The probability of another 25bps rate cut from the Fed by the July FOMC meeting has increased up to around 80% and to around 60% for June.

The other important factor that has contributed to a weaker US dollar has been the general sense of relief so far this year that President Trump’s tariff announcements have not been as bad as feared. So far the main tariff hikes implemented have been the 10% uplift on imports from China. He also announced plans to implement 25% tariff hikes on steel and aluminium from all trading partners although they are not scheduled to take effect until 12th March providing some time for trading partners to try to secure exemptions. The slower implementation of tariff hikes was again evident last week when President Trump announced his plans for “reciprocal tariffs”. He has ordered Commerce Secretary Howard Lutnick and US Trade Representative Jamieson Greer to propose new “reciprocal tariffs” on a country-by-country basis in an effort  to rebalance trade relations. It would be a big structural change to the trading system and could take months to complete. Howard Lutnick is optimistic though that it should be complete by 1st April and then President Trump will act immediately.  

The finer details of how President Trump will implement “reciprocal tariffs” remains unclear and will rest on the methodology that Howard Lutnick and Jamieson Greer will come up with. President Trump is directing that “reciprocity” is based not just on the tariffs imposed by other countries on US imports, but also a range of other non-tariff factors including: i) other countries’ taxes such as VAT imposed on US imports, ii) exchanges rates, iii) government subsidies for companies in their home countries, iv) bilateral trade balances with the US and v) regulations which are more difficult to quantify and considered on a case-by-case basis. It will create additional uncertainty over the potential negative impact of the tariffs. We believe there is a higher risk now that the “reciprocal tariffs” will be implemented widely and could prove more disruptive. The incorporation of non-tariff factors makes a big difference. Please see our latest FX Weekly report for more details (click here).                

In light of these developments, we are not convinced that the recent US dollar sell-off will be sustained for long. The final methodology for determining what “reciprocal tariff” hikes to implement will be important in determining how disruptive they are for global trade and growth. We are wary of a more disruptive outcome now that non-tariff factors will be included. Additionally, ongoing trade policy uncertainty on its own should remain supportive for the US dollar until there is more clarity and could help limit room for US dollar weakness to extend further in the near-term. A deeper correction lower for the US dollar would provide more attractive levels to buy US dollar’s heading into Q2 while plans for reciprocal tariff hikes are finalized. 

USD LONGS CUT BACK BUT STILL ELEVATED

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Country	GMT	Indicator/Event	Period	Consensus	Previous	Mkt Moving
EC	10:00	Eurogroup Meetings	--	--	--	!!
EC	10:00	Trade Balance	Dec	14.4B	16.4B	!!
GE	11:00	German Buba President Nagel Speaks	--	--	--	!!
CA	13:15	Housing Starts	Jan	251.0K	231.5K	!!
US	23:00	Fed Waller Speaks	--	--	--	!!

Source: Bloomberg