Speaker 15:
Hello and welcome to Macro Minutes. During each episode, we'll be joined by RBC Capital Markets experts to provide high conviction insights on the latest developments in financial markets and the global economy. Please listen to the end of this recording for important disclosures.
Elsa Lignos
So welcome everyone to Macro Minutes. Today is the 1st of July 2025 and this edition is called Continental Drift. My name is Elsa Lignos, I head up the global ethics strategy team at RBC, and I'm joined today by two fantastic colleagues, our Head of US Rate Strategy, Blake Gwinn, and our Chief European Macro Strategist, Peter Schaffrik. Now normally as host, I would kick off the questions, but Peter has insisted on taking the first one given what's been going on in currency market. So, Peter, over to you.
Peter Schaffrik:
Yeah, thank you, Elsa, for giving me the first shot here. So I'd really think we should be talking about the dollar and we've just hit a three-year low in the dollar index today. And given that this is your domain, does this move still have legs?
Elsa Lignos
Well, it's interesting. I actually just got back from a week of meetings in the US and Canada. So we saw clients all across the coast, New York, Boston, Montreal, and Toronto and investors were pretty much unanimously bearish dollars, but despite that, they're not as heavily positioned as they would like. To give you an example, I spoke to one PM who told me he was more short dollars than he'd ever been in his career, but added he felt that he was not short enough and several others had been waiting for dollar rallies to sell into and were under-positioned as a result.
Peter Schaffrik:
So as a follow-up then, so what do you think are the primary drivers behind the dollar weakness that we're seeing?
Elsa Lignos
Well, there are two main arguments you hear. One is this idea of asset reallocation away from the US and two is a cost-of-carry argument, I.E., the idea that as the fed cuts rates, hedge ratios will rise further. We of course tackled that in a previous edition of Macro Minutes on one. There was definitely a surge in interest in European assets, European equities at the start of the year. It peaked around the time of the German fiscal announcement, but US tech really still dominates equity flows and both US and Canadian investors told us straight up, "If you want exposure to the secular themes of tech AI, you have to be in US equities," and you can see that US equity outperformance in Q2, which reinforces that view so that someone leaves you with this cost-of-carry argument. And I'm going to loop in Blake into the conversation in a bit because clearly expectations around the Fed have been a big driver of that.
But it's interesting, it's not just hedging flow. I think there is also a lot of speculative positioning and anticipating that hedging flow. And why do I say that? Talking to our forwards traders, as you know, we run a very big forwards business here at RBC, if we were seeing that hedging flow materialize, you'd expect to see the basis turning more negative and that's not actually what's been happening. So there's certainly hedging flow that's taking place. There's also speculative positioning that's anticipating that hedging flow, which is due to take place and you put it all together and it combines into this very powerful bearish dollar consensus, but one which is possibly still under-positioned. And as a result, investors are still looking for opportunities to sell into any sort of dollar rally that they see.
Blake Gwinn:
So, Elsa, before we turn the microscope in my direction, I guess just one last question, any other big takeaways from the trip you were mentioning? Any big views out there that you'd like to go over?
Elsa Lignos
So one question that came up quite a bit is how are people playing short dollars and the most popular long on the other side is definitely euro, that's consistent with our positioning monitor where we see positioning heaviest in long euro dollar at the moment. It's almost at the max ever long as of this morning, but we're also seeing long euro positioning on the crosses. So we've got pretty crowded long euro yen market is long euro CAD, long euro sterling, but sitting around 30% of the largest ever long. And we'll loop in Peter later on the conversation to discuss Europe, but investors still see the fiscal tailwind in Germany as a primary driver. There is this widespread view that European investors are heavily overweight US equities, which is backed up by the stock data, but the evidence that they are liquidating those haltings has stalled in Q2 as I said.
And then outside of that, the other thing we spent quite a bit of time discussing was the bull thesis for the dollar. I mean we all agree on this very consensus view that the dollar is going down from here. So we challenged ourselves to come up with ways that the bearish dollar consensus could turn out to be wrong. And there were a few different things we all kind of collectively came up with through client conversations. I mean one is any kind of upside surprise in US growth and linked to that any upside surprise in US inflation. In short, pretty much anything that would prompt the market to push back the timing for Fed cuts. Alongside of that you could see escalation in geopolitical risk. Though to be perfectly honest, clients do see that as a low probability event, particularly given the speed of the fade of the market reaction to the previous weekend's bombings of Iran and the third one that got mentioned but seen as a very low delta event as downside surprises in rest of world growth.
I mean if you had to list one scenario as being potential to cause the biggest surprise, it would be that because really at this stage everybody's leaning towards a fairly constructive rest of world view. The last one that I'd mention is tariffs. And I know we're kind of coming up to the deadline for the 90-day pause next week and tariffs on the whole are still seen as generically dollar negative. But I do think you can make the case that singling out a particular country could be dollar positive for that pair. Now I'm conscious this is a pretty off consensus argument, but if you think about how the dollar was hard hit in April by the sharp re-rating of US growth prospects, with that damage now done, you could make the case for the dollar to react differently.
If Trump is singling out a particular country or a handful of countries, you could see a bit more scope for substitution, more scope for the exporter to be hit harder than the importer. But like I said, I'm aware that's not the consensus at the moment. So, Blake, let me turn it to you. You've been in the September camp for a while now and as I said, this is a key pillar of the bearish dollar thesis that's out there, but Trump has really ramped up the pressure on Powell and as of yesterday, even the rest of the Fed board to cut rates in the last few weeks. Do you think there's any chance that the chair caves, do you think we could see a July cut?
Blake Gwinn:
No, I don't. I mean I think we've seen Powell repeatedly demonstrate his lack of interest in what Trump has to say on monetary policy and that even goes back to Trump's prior term. So I think a July cut seems very unlikely. We've had a couple of doves, Waller, Goolsbee, Bowman kind of raise that possibility over the last week or two and those comments definitely got some attention. But if we look at where the June SEP dots were, the entire distribution of those dots for 2025, the comments we got from Powell and also our expectations for some continued softening in the labor and activity data over the next couple of months. I still think first cut in September is the right call and we have 25 basis point cuts after that until May of 2026 when you get to a terminal rate somewhere around 2.75 to 3%, which I think is in line with where most on the committee would generally put the long run neutral level.
I would say even around September, I actually think the risks are more skewed to a later start than an earlier. So I'd be more worried about sliding that September timeline out than actually worrying about a cut coming in July. And I would also say that the tariff changes that we may get, remember we have this July 9th date kind of hanging over our heads. We've still got this court case on IEEPA authority to basically implement tariffs still kind of hanging out in the air. Those are things that could definitely extend this kind of wait and see period and just keep the Fed on hold for longer. But I would just say at a very high level there's really no urgency for the Fed to act here with core PCE still around 2.5% and unemployment rate still stable even though taking up very slightly at around 4.2%.
Basically we see two past to cuts from here. You either see the tariff inflation impacts prove benign, so you get this kind of continued gradual preemptive cuts back to neutral. It's just kind of picking up where the Fed basically left off with the last cutting cycle. And to that point, I think Powell has said that they are still thinking tariff impacts could show up this summer, which I think actually lends itself to our September timeline just because can't really falsify these inflation concerns until you see that June and July data, which we're not really going to get a handle on until August. So I think that makes a July cut very difficult. Just that Powell is saying that these inflation risks that we're worried about are going to be later this summer. The other path to cuts could obviously be that labor growth deteriorates a lot more sharply, but we just haven't really seen that.
We've seen some very, very modest cracks starting to be created. I don't even know if you could call them cracks yet. It's almost more the start of something that could eventually be a crack, but we have seen some slowing on the labor side. I've gotten a lot of questions about what we would have to see in NFP this week. We are recording this before the Thursday NFP release. I've gotten a lot of questions about what we would need to see there to get the Fed cutting in July. I really don't think there's a scenario that gets us there. I think even if you see something like a sub-50K NFP, a tick up to 4.4, 4.5 on the unemployment rate, they'd still probably in my mind be using July as a setup meeting for a potential cut in September. So really just signaling that if the data continues down that path for the two months into the September meeting, that's where we would be more likely to see the cut. I still don't think we're getting that July cut.
Elsa Lignos
Makes sense. But part of the pressure Trump has been trying to put on Powell is also through talking about his eventual replacement. So you've mentioned there's this increased discussion around post-Powell trades basically playing for cuts after his replacement is presumably sworn in. How are you thinking about that replacement conversation and the trade that people are trying to put on for sharp cuts?
Blake Gwinn:
Yeah, I've generally pushed back against that for a number of reasons. I think one, Trump still has a long way to go to get a candidate through to the Fed chair spot. He has to get through Senate approval. We've seen in the past that the Senate banking committee has rejected people that Trump has chosen. Now he does seem to have a little bit more control over Congress this time around than his last term, but last time we did see several of his candidates get either voted down or basically told that they were not going to make it through approval and withdrawn during his last term. So they're still kind a wall. It's not like he just gets to name somebody. They're going to automatically be in place. And I think the more that person is seen as of a Trump loyalist if you will, the harder it's going to be for them to get through that approval process.
I would also just say that you tend to think of the chair being able to kind of control rates, but the rest of the FOMC does have to agree to that this isn't a dictatorship, they still take a vote. Now we're used to the FOMC making policy by consensus, but that relies on the respect and the back and forth discussion between the committee and the chair. And so if you've got somebody that came in and against the will of the committee said, "Hey, I really want to start slashing rates here," we could see a scenario where those votes instead of just being what they have been in the last decade or so, which is largely symbolic, it could actually be an operational vote and we could see the committee actually voting against what the chair wanted to do.
So that's certainly a possibility there as well. And lastly, I would just say if you believe our forecasts the September cutting cycle through to May of next year by the time the new Fed chair gets in and the second half of '26 will already have just gotten out of a cutting cycle if we're right. So conditions could be a lot different by then and I just think it's very tough to kind of think about where we're going to be in a year's time.
Elsa Lignos
Blake, you have also pointed out that he may actually need to use the spot in January to get his chair onto the board if Powell's not stepping down.
Blake Gwinn:
Yeah, absolutely. And this is like... I don't think this is quite... Some people have said, "Oh, he's doing this very early," but he does need to use that January spot because the way it works is that the person that he selects to be chaired does have to be on the board and they're only really going to have one spot. If Powell decides that after he's done with his chair term he wants to stay on the board, that means there's only really one slot that they have to put somebody new onto the board and allow them to choose an outsider when Powell's chair term is done in June of 2026. So that's the Kugler seat, which is going to be open in January. So they do need to put their presumptive chair pick in place in January. And so this kind of six months type of lead time, it's not really that wild. It's not that early to start thinking about filling that January seat, which will presumably go on to be a Powell's replacement as chair.
Peter Schaffrik:
Blake, can I just move the debate on a little? And so on a somewhat different note, it does seem like the so-called big beautiful bill is gearing up towards the end game and thoughts around that process might be really appreciated. What do you think?
Blake Gwinn:
Yeah, I mean at this point, so we are really nearing this kind of self-imposed 4th of July deadline that they've kind of set on themselves. Everything's very fluid. By the time you're listening to this, maybe we have already gotten a vote. I do tend to think there's still a lot of breakdown inside of the GOP as far as people who are saying they're not going to support this. That's true both in the Senate version they're trying to pass right now. There's some senators that they've got four ish, five ish senators that look like they may be nos, a few of those are certain nos. They can only afford to lose three. So definitely still some question marks around that process. And then it obviously has to go back to the house. The Senate version has to go back to the house and there there's been a lot of rumblings that some of the more conservative members of the house don't want to support the version that's coming out of the Senate.
So it still has roadblocks, but my view on this stuff is that it's very hard to stop this momentum in that with the weight of the White House and Trump making personal calls to these people, the resistance is not really going to hold up for long. So I do think something gets through here. The major impact for us in markets I think is really coming through some of the debt limit dynamics because there will be a debt limit increase that's associated with this. I think markets have generally been looking at the debt limit being resolved towards the end of August, which is when we think the, quote, unquote, X date, when the government runs out of money, we've been looking at that kind of timeframe with a big, big ramp up in supply coming after that X date.
Well, if this passes in the next week, then treasury can start ramping up that supply and rebuilding their cash balance as early as second half of July. So it really kind of shifts that timeline. All the people that have been avoiding those August maturity bills and thinking about playing those impacts of the supply surge that we're going to get after a debt limit resolution, that timeframe is basically pulled up into early July. So I think that's one of the most immediate impacts of the passage of this bill.
Peter Schaffrik:
Blake, if I could follow up there, you just mentioned ramp up in supply, which is basically all about the deficit, which gets a lot of our time in the public debate, but I'm not quite sure we're really seeing it in markets. Do we? So treasuries have been rallying lately. Long end swap spreads have been widening, the yield curve has even been flattening the last few sessions. So what's going on?
Blake Gwinn:
Yeah, I think about a month or so ago, I think there was a real flurry of activity around and discussion around this kind of idea of higher deficits, term premiums, steeper curves, a long end swap, spreads falling, et cetera. But I think that was really a product of two things. One is that we kind of had this narrative vacuum. The Fed was firmly in wait and see territory. Everybody kind of knew that the data that was coming out for March, April and May was a little bit noisy because it hadn't really incorporated the impacts of Liberation Day tariffs yet. So that kind of macro narrative was very, very quiet and I think it allowed this vacuum where then comes the second part, which is you had the US downgrade, you had the house initially passing that bill, and we saw this little mini flurry of concerns around the deficit and term premium discussion, et cetera.
Now why that's kind of quieted down and why we're not really seeing as much of an impact as this bill nears the finish line is, I think for one we've basically been priced in. I mentioned that we already kind of did this when it passed the house about a month ago, but really you could roll this all the way back to November of last year. I mean expectations for what Trump and a red sweep were going to mean for the deficit were already very high. And if anything these numbers we've seen around this bill, the estimates of the deficit impact are actually smaller than what some people were expecting back around the time of the election. So to some extent this should largely be priced at this point, the deficit impact. The other is that the Fed and data is kind of back to the forefront as we're starting to get towards the end of this wait and see period.
And we're entering into a run of a few meetings where we could presumably see the start of the cutting cycle. I mean these meetings are getting live again, and I think the Fed and the data are really what tend to dominate the market narrative and I think it has kind of left less oxygen for some of these supply issues, deficit concerns to really come to the forefront. The last thing I would mention is that some comments both from Bessent and on some regulatory developments that we've had that are both on net supportive for long duration. Bessent yesterday threw a large bucket of cold water on this idea that they're going to fund the deficit with any kind of longer end issuance. He was kind of asked about this and kind of shrugged their shoulders and say, "Why would we issue a lot of elongated treasuries at these types of yields?"
So it gets to a point that we've been making for a long time, which is the deficits don't automatically mean curve steepening term premium, et cetera. Because that really depends on how the treasury chooses to fund that deficit. And so this is kind of the clearest indication we've got from Bessent that they are thinking about leaning more on front-end issuance to fund that deficit. And if so, all those impacts you were kind of mentioning curve steepening, long end spreads, et cetera, those kind of deficit trades really work on the idea that they're going to fund it in 10s and 30s. The last I would say is just we did get some updates on SLR, supplementary leverage ratio that are generally seen as positive for treasuries and spreads here. So that's probably adding to some of that momentum. We wrote a big piece about this last week, which you can see on RBC Insight for your clients, but that's a much deeper issue, which as I said, we covered in that piece.
Elsa Lignos
Peter, let's turn to you because we spoke about dollar weakness earlier, but of course the flip side of that is euro strength and the ECB doesn't usually react to currency movements much, but we have seen comments from ECB members at the Sintra Forum today and yesterday. Where's your head at?
Peter Schaffrik:
Yeah, thank you, Elsa. I think it's a really interesting one here because I mean first of all, without stealing your thunder, but you spoke very eloquently about the dollar. But then when you look at what's happening more broadly, obviously over here the euro has strengthened against the dollar. But what also is very important, the euro has strengthened particularly also against the renminbi for instance. And that's of course a trading partner that we have, let's say a very large trading relationship with which is currently not really going into our favor.
And we had that debate before, I believe in a previous episode of Micro Minutes, that one of the fears of course over here in Europe is that cheaper Chinese goods come into Europe and push down on inflation and obviously as let's say renminbi moves, that fear gets louder. So I wouldn't necessarily say that the ECB is immediately going to jump on it, but given that these cross dynamics are there, I think they're probably a little more attentive, although they would never say that out loud and that will have to be seen. Also, if I may, I think there's also an implication how the negotiations are going to go between the EU and China in particular against that backdrop, which was supposed to come to a conclusion in July.
But I haven't really seen anything tangible on that front. So I think the ECB is close to being done. We're pricing in one further cut. I think that's probably the most likely path. But if this continues, it does put more pressure on the ECB to potentially do something, or at least to phrase it more conservatively opens the door a little bit further. But it's not our call and I definitely think the ECB is not going to jump on it straight away.
Blake Gwinn:
So, Peter, let's move that conversation out the curve a little bit. I mean, as we just discussed, we've seen treasuries rallying, we've seen gilts rallying, but bonds and European bonds more broadly generally have not. Do you think that kind of differing performance is justified?
Peter Schaffrik:
Yeah, actually I do. And I give you two reasons for it. I mean one is centered around what I was just alluding to. So whilst the ECB is probably have one eye on the currency market, what they have been communicating lately is that they're in a good place. They have been obviously much faster cutting rates than either the Fed or the Bank of England for instance, but now at 2%, maybe they go to 1.75, but that's in the forwards already. So it seems very difficult in my mind at this stage to drive our markets over here in Europe through the front end. And obviously as you were saying earlier, or as we discussed earlier, one of the reasons for the recent performance came out of the front end where the market has been pricing more fat rate cuts and that simply wasn't joined by the euro market because we've been there already.
Slightly different for the sterling market of course, because the Bank of England has been quite reticent and that has been pulled along to the front end of the SONIA curve, for instance, has been pulled along by the SOFR curve. And that's in my mind one of the key reasons why we have seen that outperformance of dollars and gilts over bonds. But then there's a second element, and I also want to pick up on what you said earlier. You spoke about sort of the deficit and the term premium and what have you, and that we've priced that earlier in the year already in the dollar market. And I've been very vocal about this that we haven't really joined that to the same extent in the euro market yet. So we're lagging behind what is priced in other markets already. And every time there is something about deficit, deficit spending, increased funding, any of that kind of motion in the market, we see a bit of a jolt at the back end of the curve.
And obviously this is also holding back the back end of the curve from performing in the first place. And just earlier, not this week, but last week we had the funding update of the Q3 calendar for Germany, for instance, the German budget has been announced that really brought home the message that there is a lot of funding to do. And lo and behold, what we've seen is a steepening of the curve, particularly in the 30 years. And it has also shifted the bond yields higher whilst at the same time the rest of the market was performing. So there's really these asymmetric moves that we're sometimes seeing, which in my mind have something to do with this combination of a front end that's already well priced and the supply dynamics that in my mind have not really been fully priced as of yet.
Elsa Lignos
Peter, one final question from me. Is it justified that gilts have rallied in sympathy with the treasury market or is there something brewing in the UK that justifies the recent move and the gilt out performance that we've seen versus bonds?
Peter Schaffrik:
Yeah, thank you, Elsa, for the question. It's definitely a topic that's very dear to our heart. So first of all, I would say there is, let's say just a cross market feed through coming from the US. The gilts market generally is trading closer to the treasury market than it is to bonds. So typically when treasuries perform against bonds, gilts do too. So there is an element of that. However, having said that, I think there's also some UK domestic developments. So we have seen some tentative data weakness in the labor market in particular. And that's obviously one of the key things that has been holding the Bank of England back in the last Bank of England meeting for instance. What we've also seen is we've seen one more member joining the cutting chorus. So we had three dissenters, the market was just looking for two and the person who dissented is also an important member, is Sir David Ramsden.
So there were quite a few indications in that direction as well. And then a little bit more dovish comments coming from the Governor Bailey himself. And that led to the market pricing in more of rate cuts, particularly for the next meeting in August where we have long argued that was underpriced anyway, but also a little further out the curve. So we have joined the US Treasury rally much closer, but there's also good arguments and why the market was underpricing what the bank eventually or we think what the bank would eventually deliver. And that has driven the outperformance that I mentioned earlier. We think it's probably close to be done by now. We're not fully priced for what we are expecting and we might see a little bit more, but the air is also getting a little bit thinner there, I have to say.
Elsa Lignos
Got it. Thanks, Peter. So looks like the UK may have done enough for now, but does look like the UK warrants an episode of its own in the near future. So thanks again to my colleagues, Blake and Peter, for joining me today. And thanks to everyone listening to our Macro Minutes podcast. That's a wrap from us and bye for now.
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