Dollar on the Defensive: Markets Grapple with Deficit Fears.

  • US deficit fears tied to a revised tax bill have driven a selloff in the dollar, equities, and Treasuries, with further volatility possible today.

  • Weak Treasury auction and a widening 10Y UST-SOFR spread signal deepening market stress.

  • G7 summit headlines and today’s S&P Global PMIs could sway sentiment and determine whether the dollar finds a floor or resumes its decline.

  • EUR gains momentum, helped by risk-off flows and ECB stress-test concerns over potential Fed USD liquidity tightening.

  • GBP holds steady, with markets still pricing in a summer BoE cut and EUR/GBP likely needing calmer conditions to dip below 0.840.

USD: Deficit Jitters Dominate

We previously highlighted the potential for pro-USD headlines out of the G7 finance ministers’ meeting in Canada, especially if trade tensions cooled. But with discussions wrapping up today and no major headlines yet, the market’s focus has shifted elsewhere—specifically to the US tax bill drama.

House Republicans are racing to push through a revamped tax plan before the Memorial Day break. The proposal raises deduction limits to win over moderates while fast-tracking Medicaid cuts to appease conservatives. This has intensified concerns over the growing US deficit, triggering a broad selloff in both equities and bonds. The dollar slumped across the board, and a weak 20-year Treasury auction added fuel to the fire. The 10Y UST-SOFR spread widening to -58 hints at fresh stress in US fixed income markets.

While there are some early signs of stabilization in equity futures and Treasuries, the threat of another volatile trading session looms. Any encouraging news from the G7 could help stabilize the dollar, but the sharp market reaction post-‘Liberation Day’ (when confidence in US assets faltered) underscores just how fragile sentiment remains.

If today’s S&P Global PMIs disappoint—falling below the 50.0 contraction line that’s been in place since early 2023—it could spark another leg lower for the greenback. Tentative support might emerge, but upside in DXY above 100.0 may still invite selling.

EUR: Eyes on PMIs

European currencies are benefiting from risk-off flows out of the US, with last week’s Reuters report adding momentum. That report claimed the ECB is asking banks to stress test their USD funding amid concerns the Fed could restrict swap line access. While unlikely, it has markets hedging.

The spotlight today is on eurozone PMIs and Germany’s Ifo index. Both are expected to edge up slightly—probably not enough to derail expectations of 50bp worth of ECB rate cuts this year.

We believe EUR/USD heading for 1.150 is premature unless we see clearer economic divergence between the US and Europe, a disappointing G7 summit, and further Treasury market stress. Still, the setup for a continued euro climb remains in place.

GBP: EUR/GBP Dip Postponed

UK inflation data showed a temporary bump in services CPI, driven by Easter-related spikes in airfares and holidays. These effects are expected to unwind, with other areas—like restaurants, healthcare, and rents—showing disinflationary signs.

While markets still see a 50/50 chance of an August rate cut from the Bank of England, the pound hasn’t gotten much help from this latest CPI release. EUR/GBP is holding up, buoyed by broader market instability sparked by US events.

We continue to see room for EUR/GBP to dip below 0.840, but more stable market conditions will likely be a prerequisite.

*All rates shown are indicative of interbank rates and should only be used for indication purposes only. It is important to note that foreign exchange rates fluctuate and that rates may vary depending on the amount and the base currency that is purchased or sold. Rates are correct as of 8:00am UK time. CentralFX are not responsible for the rates shown.