Dollar on defensive after Moody’s downgrade
The dollar chalked up modest gains against the euro and sterling on Friday, reaching intra-day highs of around $1.1130 and $1.3245 respectively, following the release of firmer than expected US inflation-related data. However, it has retreated again following Moody’s one-notch downgrade to the US triple A credit rating, announced after the close of business on Friday, trading at around $1.1240 and $1.3360 this morning. EURGBP is hovering just north of £0.84, having shed around half a penny last week, ahead of today’s UK-EU summit in London, which is not expected to deliver much in the economic area at least.
US government bond yields are inching higher following the Moody’s downgrade. 10-year yields are back above 4.50%, bringing the cumulative increase since last Monday’s announcement of the US-China trade ‘deal’ to almost 15bps. Equivalent UK and German yields have seen more modest increases over the same period, of about 8bps and 3bps respectively. Meanwhile, US equity markets rallied impressively last week on the back of the US-China deal, with the S&P 500 gaining 5%, while European stocks saw gains of around 2%.
Moody’s downgrade to the US credit rating (from Aaa to Aa1) follows similar moves by S&P and Fitch. Not surprisingly, Moody’s cites concerns about the country’s deficit/debt position as the reason for the downgrade. It says it expects “Federal deficits to widen, reaching nearly 9% of GDP by 2035, up from 6.4% in 2024, driven mainly by increased debt interest payments on debt, rising entitlement spending and relatively low revenue generation.”
Staying with the US, the latest University of Michigan survey showed another fall in consumer confidence in May and another increase in consumers’ short- and medium/long-term inflation expectations. The latter increased to 4.6% from 4.4% in April and a low of 3% as recently as December, reflecting households concerns about the impact of tariffs on consumer prices.
In an FT interview, ECB member Wunsch said developments since Trump’s tariff announcements in April have created clear downside risks to inflation in the Euro area, adding that the central bank may have to cut interest rates to “slightly below” 2%. His colleague Schnabel was more circumspect in comments over the weekend though, saying that “we can leave rates broadly at the level they are at now and are confident that we can also maintain price stability in this way.” The market last week pared back expectations for ECB cuts, with circa 50bps now priced in for the rest of this year.
Looking to the week ahead, the main economic data releases include flash PMIs for May in the main economies on Thursday, and CPI inflation and retail sales in the UK on Wednesday and Friday respectively. Meanwhile, the European Commission publishes its Spring Economic Forecasts later today.