Key Takeaways:
Tariff refunds may ease pressure on US businesses and households, but weak growth and sticky inflation leave the dollar's trajectory uncertain across USDJPY, EURUSD, and GBPUSD.
The US dollar faces an uncertain outlook as tariff refunds offer relief to businesses and households, yet weak growth and sticky inflation complicate the Federal Reserve's policy path across three major FX pairs. The Fed held its benchmark rate at 3.5% to 3.75% at the last meeting, with four officials dissenting — the largest number of "no" votes since 1992, signaling internal division over the inflation outlook.
"Central banks are likely to stay hawkish for now, but we still think it's probably a one-and-done hike from the ECB," said James Smith, developed markets economist at ING. "The Fed will ultimately cut rates again, maybe as soon as December."
The 30-year US Treasury yield surged above 5% to hit 5.15%, while the 10-year yield reached 4.70%, reflecting investor concerns about inflation and fiscal deficits. The University of Michigan survey showed five-year inflation expectations rose to 3.9%, the highest since June. Across the Atlantic, the UK 30-year gilt yield climbed to 5.85% and Japan's 30-year JGB yield hit 4.20%, as global bond markets price in prolonged monetary tightening.
For currency markets, the divergence in rate expectations creates divergent paths. USDJPY targets the 160-162 zone as US yields remain elevated and the Bank of Japan faces rising fiscal pressure from JGB yields that have surged more than 1,100% over the past decade. EURUSD faces resistance at 1.19 with support at 1.12, as the European Central Bank's expected 25-basis-point rate hike in June does little to close the yield gap with the US. GBPUSD remains rangebound between 1.30 and 1.3780, awaiting a catalyst for breakout as UK gilt yields at 5.85% raise concerns about fiscal sustainability.
Tariff refunds offer limited relief
The tariff refund program, announced May 30, aims to reduce cost pressures on US importers and consumers after months of elevated trade barriers. But the relief may be temporary. The last time the US implemented broad tariff relief in 2020, bilateral trade flows recovered by roughly 15% over six months, according to Census Bureau data, while the dollar weakened 4% against a basket of major currencies over the same period.
This time, the backdrop is different. Energy costs remain elevated, with ING estimating oil prices will stay above $90 a barrel this year even if Strait of Hormuz flows normalize. The combination of tariff refunds, higher energy costs, and a tight labor market — nonfarm payrolls have averaged above 100,000 per month — leaves the Fed with limited room to ease.
Rate differentials drive FX divergence
The dollar's trajectory hinges on whether long-term Treasury yields can sustain their recent declines. The 30-year yield has corrected from its 5.15% peak but remains above the 5% threshold that signals persistent inflation and fiscal concerns. A sustained move below 5% would ease pressure on risk assets and potentially weaken the dollar, while a renewed push higher would reinforce the greenback's strength.
USDJPY remains the most sensitive to rate differentials. The gap between US and Japanese yields has narrowed as the Bank of Japan raised rates, but the yen continues to weaken as JGB yields rise on fiscal concerns rather than economic strength. Japan's debt-to-GDP ratio, nearly double that of the US, makes its bond market vulnerable to further selloffs.
EURUSD faces headwinds from Europe's own bond market stress. French and Italian 30-year yields have risen alongside US Treasuries, and the ECB may need to activate its Transmission Protection Instrument if the selloff accelerates. That would limit the euro's ability to rally even if the ECB delivers its expected June rate hike.
GBPUSD remains stuck in its 1.30-1.3780 range. The Bank of England faces a difficult choice: inflation remains above target, but the jobs market is fragile and higher gilt yields threaten to tighten financial conditions further. A durable resolution in the Strait of Hormuz could remove one argument for rate hikes, but the BoE is unlikely to signal an all-clear anytime soon.
This article is for informational purposes only and does not constitute investment advice.
