May 2025 Monthly

The global economy has entered a phase of heightened uncertainty, and at the center of this instability stands the United States. In a reversal of its traditional role as a pillar of predictability and leadership, the U.S. has adopted an erratic posture—rife with sudden feints, policy reversals, and institutional strain. Nowhere is this more evident than in the Trump administration’s economic and foreign policy strategy, which increasingly appears less a coherent vision and more an exercise in disorienting escalation.

The administration has consciously adopted the “flood-the-zone” tactic—an overwhelming rush of policy actions that stretches constitutional norms and leaves the public, media, and institutional checks struggling to keep pace. These are not limited to tariffs or trade, but extend to executive overreach, budgetary assaults on multilateral institutions like the WTO, and even aligning the U.S. against traditional allies in critical forums such as the United Nations and the G7. Blocking a G7 statement condemning Russia’s latest assault on Ukraine exemplifies this new unilateralism that is sowing diplomatic confusion abroad and political fragmentation at home.

Amid this swirl of uncertainty, warning lights are flashing across the U.S. economy. A sharp divergence has emerged between “soft” data—such as business and consumer sentiment surveys—and “hard” economic data like payrolls and output. Yet even the hard data is beginning to creak. Payroll tax withholdings are showing signs of decline, potentially signaling early weakness in the labor market. This is likely to worsen given mounting layoffs in government sectors and the ongoing formal and informal curbs on immigration. If the surveys are a harbinger, a material downturn may be nearer than Washington wants to admit.

On the global front, America’s strategy to decouple from China is proving disruptive. While U.S. officials and some economists deny it, arguably holds “escalation dominance” in the trade dispute. In the near to medium term, China can more easily replace U.S. demand than the U.S. can substitute its reliance on Chinese consumer electronics and rare earth processing. Moreover, China’s economy is showing surprising resilience. Domestic consumption continues to rise even if investment is keeping pace if the official data can be taken at face value.

Beijing has indicated a willingness to provide more monetary and fiscal stimulus to strengthen domestic demand. Its exports, once heavily U.S.-centric, are now more diversified, and its currency has weakened meaningfully against the euro and yen—adding a tailwind to competitiveness outside the dollar zone. The US unilateralism risk deflecting Chinese surplus production to other countries, which may force them to adopt their own protectionist measures.

Meanwhile, anti-American sentiment is rising, especially among close allies. Reports of consumer boycotts in Europe and Canada, coupled with a steep decline in U.S.-bound tourism can be expected to adversely impact America’s hospitality and retail sectors. While some speculate a capital strike may be under way, it is too early to confirm given the inherent lag in financial flow data. Nonetheless, increased flows into Europe-focused funds hint at broader repositioning, potentially even by U.S.-based investors.

In anticipation of new import duties, firms have accelerated purchases, boosting sales and inventories temporarily. U.S. auto sales surged as a result, but what happens when that wave crests and consumption pulls back? Inventories will be run down and then businesses will face a choice but if anticipated weaker labor market and a pullback in consumption materialize, business may be reluctant to boost output in such a context.

Markets sent a clear message in April. U.S. equities, bonds, and the dollar all sold off in a dramatic repricing. Former Treasury Secretary Larry Summers likened it to an “emerging market moment”—a comparison we think is overblown but not without resonance. The Trump administration, perhaps spooked by the reaction, paused implementation of its so-called reciprocal tariffs. Yet the broader trajectory remains unchanged. New investigations have been launched targeting pharmaceuticals and rare earths. The US is threatening action on lumber, and dairy, as well. Additional tariffs are reportedly being prepared, and new fees on foreign cargo ships—particularly Chinese—are set to begin in the fourth quarter.

After disrupting businesses and markets with auto tariffs, due in early May, President Trump signaled that he is considering a postponement. Yet, again, this looks less like a policy rethink and more like tactical maneuvering to manage market sentiment and geopolitical blowback.

Global monetary policy is adjusting in response to U.S.-driven turmoil. Downside economic risks have increased. Among the G10, the central banks of the U.K., Australia, and New Zealand are expected to cut rates in May. Among emerging markets, Mexico is poised to slash by another 50 basis points, while Brazil swims against the tide with continued tightening. South Korea, Poland and the Czech Republic may also cut rates. 

The Federal Reserve, by contrast, is likely to hold steady. Inflation remains sticky and the labor market appears resilient—at least for now. But political interference looms large. President Trump has publicly criticized Chair Jerome Powell, and reports suggest the White House is exploring ways to remove or sideline him. Thus far, markets have taken these threats in stride. But should the administration escalate—through an actual firing or the appointment of a “shadow” Fed chair—market volatility could surge.

Congress may also start pushing back. As trade tensions deepen and emergency powers are increasingly invoked to justify unilateral tariffs, bipartisan voices in Washington are beginning to challenge the constitutional scope of executive authority. Legal battles and legislative efforts to claw back trade powers may become a defining issue in the months ahead. Around a dozen US states are suing the federal government for executive overreach, claiming that the tariffs are a tax and that is beyond presidential power. 

All of this—economic dislocation, institutional strain, foreign backlashes are already registering in the currency markets. The dollar has weakened significantly. Although it may be technically oversold and due for a short-term rebound, the broader trend appears firmly downward. A retreating greenback reflects not just monetary conditions, but global doubts about America’s direction and dependability.

In the postwar era, U.S. leadership was defined by a commitment to rule-based order, economic openness, and institutional integrity. That architecture is fraying. Whether by design or dysfunction, Washington is forcing the world to reprice America—not just as a trading partner, but as a systemic force. The results are showing up in markets, trade flows, and diplomatic alignments. And they may only just be beginning.

Bannockburn's World Currency Index, a GDP-weighted basket of the currencies of the 12 largest economies, rose for the fourth consecutive month in April. It is the longest advance since April-August 2020 and reflects the broad weakness of the dollar. In fact, there was only one currency in the basket that did not rise against the greenback: the Chinese yuan, which fell by about 0.4%. After the yuan, the Indian rupee was the second weakest, and it was virtually flat.  

The Brazilian real and Russian ruble were laggards, rising by about 0.30% and 0.75%, respectively. The others appreciated by at least 2.2% against the dollar, led by more than 5% gains in the euro and almost 4.9% gain by the Mexican peso. The Canadian dollar gained 3.8%, while sterling rose 3%. The Australian dollar and Korean appreciated 2.4% and 2.3%, respectively. 

We suspect that the BWCI has forged an important low. Its roughly 3% appreciation over the past four months may be a small sense of what is in store in the coming months. There may be potential for another 3-5% gain in Bannockburn's World Currency Index in the next six months, over which time we expect the Federal Reserve to cut rates by at least 50 bp. Still, given the pace and magnitude of the dollar's decline, it is vulnerable to a limited technical bounce, which ought to be seen as an opportunity for businesses with the need to buy foreign currencies.

BWCI was launched five years ago and the change in the weightings based on the World Bank's nominal GDP data is notable. Rounding to a tenth of a percentage point, only four constituents have seen their weight increase. The greenback accounts for almost 32.9% of the index, up from 30.3% when BWCI was launched. The yuan's weight has risen to 21.4% from 20.1%. The rupee's weight is now 4.3%, up from 4.0%. The peso's weight is almost 2.2%, up from a little less than 1.9% five years ago. The biggest declines have been recorded for the euro (18.6% from 20.1%) and the yen (5.1% from 7.3%). To a large extent, this reflects dollar's broad strength and the fact that the yuan shadows the dollar, generally speaking. If the dollar trends lower, as we expect, the weighting of the euro and yen will rise. 

U.S. Dollar:  Broadly speaking the dollar has been in a large bull market since early in the Great Financial Crisis in 2008. The Dollar Index peaked in 2022, but it has been mostly in a range for the last few years, until April when it broke down. On the Federal Reserve's broad nominal trade weighted measure, it peaked this past January. We suspect a multi-year dollar downtrend has begun in earnest. More immediately, we are concerned that the headwinds against the US economy will intensify, leading the Federal Reserve to resume its rate cutting cycle in June/July. Container shipments from China take around 30 days to reach the west coast US ports. There are already reports of a dramatic slowdown, which impacts trucking and warehouses, but this may only be a tip of the proverbial iceberg, as that still reflects activity before the tariffs were hiked sharply in early April. It takes the goods another 15 days to reach Houston and Chicago after California, and 25 days to reach New York. Tourist bookings to the US from Canada and Europe are evaporating. This will hit the hospitality sector hard. So far, Chair Powell's observation that the weakness is seen in surveys but not so much in the real sector data resonates with investors and business. We expect the real sector data to begin reflecting the deterioration seen in the surveys and with the government layoffs and the formal and informal curbs on immigration, the labor market remains vulnerable. China has put export controls on rare earth export to the US. Many US businesses have been building inventories, but estimates suggest they may be limited to 2-3 months. There is a recurring narrative about the dollar losing its reserve currency status. It is possible given how often it has been claimed and that central banks typically move at glacial speeds, it is prudent to wait for evidence, and unfortunately it comes with a lag. The IMF will not report the currency allocation of reserves for Q2 25 until September. Its report in June will cover Q1 25. It is common for popular narratives to attribute cyclical developments to structural forces. Domestic and foreign investors were overweight dollars and US assets. A re-balancing, albeit dramatic, appears to be taking place. 

 

Euro: The sense coming out of the World Economic Forum (Davos) in late January was Europe was "uninvestable." Many Europeans reached that same conclusion in 2024 and bought a record amount of US equities. This appears to have marked the extreme, at least in this cycle. Nevertheless, the eurozone economy continues to struggle, and the preliminary April composite PMI is at a four-month low (50.1). While fiscal support is still expected to be forthcoming, the burden to cushion the economy falls on monetary policy. The ECB has cut its key rates by 75 bp so far this year after a 100 bp reduction in 2024. The swaps market has another quarter-point cut largely discounted for the next meeting in early June. Since the last economic update in March, the euro has appreciated by about 6% and the price of Brent crude oil has fallen around 5%. These developments may weigh on price pressures. The IMF's latest forecast now sees growth this year at 0.8% down from 1.2% in its previous projections. The market expects the ECB to push the deposit rate below the lower end of neutral (1.75%) in Q4 and sees the terminal rate in 2026 around 1.25%. The euro rose by nearly 5.0% in April, which if sustained for the next few days, would not only be the fourth consecutive monthly gain, but the largest since 2022. That the large euro rally took place even as the interest rate differential (both at the two-year and 10-year tenors) does not mean that the US is emerging market, as many, including former US Treasury Secretary Summers claimed. Instead, we suggest it means that given the new political risks, investors (domestic and foreign) require a greater US premium to hold on to dollars. 

(As of April 25, indicative closing prices, previous in parentheses)  

Spot: $1.1365 ($1.0825) Median Bloomberg One-month forecast: $1.1140 ($1.0755) One-month forward: $1.1385($1.0845) One-month implied vol: 9.3% (7.6%)  

Japanese Yen:  Japan seems particularly unsettled by the Trump administration. Tokyo has feels so threatened that it is seeking to re-set its economic ties with China and resolve outstanding disputes. The minority LDP government, whose cabinet has a low level of public support, will act to shore up the domestic economy by boosting loan support and domestic demand. At the end of March, the swaps market was pricing in about 30 bp of hikes this year and now has about 18 bp discounted. The Bank of Japan meeting concludes May 1, and it will likely cut its growth and inflation forecast for this year and next. Previously, the IMF anticipated 1.1% growth this year, which was the same at the BOJ, and cut it to 0.6%. The stronger yen (~11.5%) and lower oil prices (~-10%) will likely translate to lower inflation. The BOJ's current forecasts this year's core CPI at 2.7% and next year's at 2.4%. There is much talk in the US media about stagflation, but maybe it is more apropos of Japan, which has weaker growth and higher inflation than the US is projected this year. Meanwhile, the usual sensitivity of the yen to the direction of US 10-year rates has loosened. In part, we suggest that due to risks emanating from the US the market requires a higher premium to hold on to dollar assets.

Spot: JPY143.65 (JPY148.85) Median Bloomberg One-month forecast: JPY144.80 (JPY149.25) One-month forward: JPY143.20 (JPY149.35). One-month implied vol: 11.9% (9.4%) 

 

British Pound:  In April, on the back of the dollar's slide, sterling staged a 10-day advance. It matches the longest advance in at least forty years, which it has done on four other occasions. Still, the magnitude of its appreciation was among the least of the G10 currencies. With about a 3.0% gain, sterling managed to do better than only two G10 currencies, the Australian dollar and Norwegian krone. After practically stagnating in H2 24, the UK economy appears to have found better traction in Q1 25. The economy may have grown by around 2% at an annual rate, which would be among the top of the G7. Still, the IMF cut this year's growth forecast to 1.1% from 1.6%, citing the widespread disruption from the US-driven surge in trade barriers. While the IMF forecasted UK inflation at 3.1% (up from 2.5% in 2024), it was thought to be temporary and saw scope for three rate cuts this year. The swaps market has three cuts fully discounted and about a 75% chance of a fourth cut this year. The UK has local elections on May 1. Polls put Labour, Tories, and the Reform Party at nearly a tie, and the Liberal Democrats hope to gain at the Tories expense. The Tories have the most seats to defend after doing well on the coattails of Boris Johnson's popularity in 2021.

Spot: $1.3315 ($1.2940) Median Bloomberg One-month forecast: $1.3160 ($1.2900) One-month forward: $1.3320 ($1.2945) One-month implied vol: 8.2% (6.7%)  

 

Canadian Dollar: Canada's national election is on April 28. It appears that the reverberations from the US economic threat and apparent desire to press Canada to be politically integrated in the US has altered the political dynamics in Canada and resurrected the fortunes of the Liberal Party under Mark Carney. A poll showed that nearly 2/3 of Canadians now see the US as a threat or unfriendly. Consumers are reportedly boycotting US brands, and tourists' advance bookings to the US have collapsed. While some activity to get ahead of the tariffs may have supported growth in the first quarter, the powerful headwinds look to stall the Canadian economy, if not worse, in Q2 and Q3. With a mandate in hand, Carney may offer fiscal support, and Canada has the fiscal space with a budget deficit 2% of GDP in 2024. The Bank of Canada next meets on June 4 and the swaps market are discounting about a 45% chance of a cut. Subjectively, we think the risk is higher. The US dollar is trading near six-month lows. It has fallen almost 7% from the early February high. A break of the CAD1.3700 area could target CAD1.3400.

Spot: CAD1.3865 (CAD 1.4315) Median Bloomberg One-month forecast: CAD1.4025 (CAD1.4340) One-month forward: CAD1.3845 (CAD1.4300) One-month implied vol: 6.4% (6.5%)   

 

Australian Dollar:  The Australian dollar recovered from a five-year low near $0.5915 after the so-called reciprocal US tariffs were postponed, and amid the broad US dollar sell-off, the Australian dollar reached its 200-day moving average for the first time since last November and set a new high for the year near $0.6470. A move above the $0.6550 area could target $0.6700. Australia's election is on May 3 and Labor continues hold its lead. In a world in flux, this offers a greater sense of continuity and bucks the trend against incumbents seen last year. The Reserve Bank of Australia meets on May 20. The market toys with 50 bp move, but we suspect a quarter-point move is more likely as it proceeds cautiously. Still, the swaps market is discounting 100-125 bp of cuts this year. Australia faces a difficult challenge. The Trump administration may force countries to choose between it and China. Australia straddles both spheres. It is integrated in the US security and intelligence sharing efforts, while China is by far its largest trading partner. As tensions between the US and China ratchet up, Australia may find it increasingly difficult to navigate between Scylla and Charybdis.

Spot: $0.6395 ($0.6285) Median Bloomberg One-month forecast: $0.6350 ($0.6290) One-month forward: $0.6400 ($0.6290)    One-month implied vol: 11.0% (8.5%)  

 

Mexican Peso:  The US administration is in an awkward position of criticizing and violating the USMCA trade agreement that was negotiated in Trump's first term. Still, the auto tariffs recognize an exemption autos and parts that meet the agreement's domestic content rules. Nevertheless, the combination of certainty and uncertainty weighs on the already weak Mexican economy. There may be three mitigating factors. First, apprehensions by the US border security fell by more than 25% in 2024 and the illegal crossings in March were down nearly 95% year-over-year. This may earn some goodwill from the US. Second, air-travel from Mexico to the US fell by nearly 25% in March year, over-year. If even some of those funds are spent domestically, it may help support the economy. Third, the central bank has become more aggressive in easing monetary policy. It has cut the overnight rate by 125 bp in 2025 in five quarter-point moves. In Q1 25, it cut rates twice in half-point steps and may do the same when it meets on May 15. Both headline and core inflation remain a little inside the upper end of target range (3% +/-1%) and the peso traded at six-month highs in late April. The US tariffs announcements have spurred three dollar spikes but each time, they have been sold. The dollar has fallen nearly 7% since the last spike on April 9. There  appears to be little chart support ahead of the MXN19.35-40 area. 

Spot: MXN19.5050 (MXN20.3750) Median Bloomberg One-month forecast: MXN19.9870 (MXN20.5350) One-month forward: MXN19.4840 (MXN20.46) One-month implied vol: 11.5% (13.0%) 

 

Chinese Yuan:  Exports to the US accounted for around 2.3%-2.5% of China's GDP last year. A combination of tariffs and China refusing US goods (e.g., airplanes, autos, LNG, oil, beef, and soybeans could sever the direct the trade relationship. There is also the indirect impact as US have levied an across the board 10% tariff, which also impacts places where Chinese companies (and foreign companies) have offshored mainland production. This is a headwind for the Chinese economy, while the property sector remains in its trough. Many expect Beijing to seek a significant devaluation of the yuan to blunt the impact of the tariffs, but to be meaningful it would require a potentially destabilizing large move. Instead, we recognize that the PBOC allowed for a little more flexibility in the exchange rate by adjusting the dollar's daily reference rate by more on average than earlier this year. While the yuan is little changed against the dollar this year, the greenback's weakness means that the yuan has fallen against the euro (record lows) and yen (three-year lows) and against most emerging market currencies. It Beijing does not tread gently, deflecting its exports from the US could spur protectionist action. More fiscal and monetary support is likely to be rolled out to bolster domestic demand. We expect the PBOC to continue to seek neither a weak nor strong yuan, but a broadly steady currency against the US dollar.

Spot: CNY7.2870 (CNY7.2785) Median Bloomberg One-month forecast: CNY7.3320 (CNY7.3500) One-month forward: CNY7.2135 (CNY7.1855) One-month implied vol: 4.8% (4.9%)

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