July seventh, two thousand twenty-five

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II. Insights 

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The sixth month of the broad dollar decline: the second half of the depreciation trade

So far, the trade-weighted dollar index has fallen nearly 7% over the past 6 months, a move comparable to several major dollar depreciation cycles over the past 40-50 years, In these cycles, the dollar’s trajectory during the first 6 months was fairly consistent: each began with rapid depreciation, followed by a gradual flattening.

Chart: Historical dollar cycles

1. One notable example is 2009:

Chart: Reuters report from 2009, 5

Chart: The dollar falls as the S&P continues to rise

By 10, the dollar had fallen to its lowest level in more than a year at the time, and the euro-dollar exchange rate had broken above 1.5, but the subsequent decline in the dollar was not as severe as the market feared.

"During the summer, the dollar’s depreciation looked very rapid, and people feared it might fall further and faster... Now we can see that this did not really happen. What we have seen over the past six months is simply the dollar gradually returning to its pre-crisis level."

2. However, the major dollar depreciation cycle of 1985 was an exception:

This depreciation also began with the dollar valued about 20% above fair value, much like today. The key point, however, is that even after the first six months, The Federal Reserve’s policy rate was still falling, Treasury two-year yields were declining, and key spreads such as the U.S.-Europe rate differential were narrowing, supporting a more persistent depreciation trend.

3. At this point, we appear to be approaching a key juncture in this dollar downturn.

Over the past two or three months, the dollar has weakened even though interest rate differentials remained relatively high:

This was driven by investors holding U.S. assets adjusting their hedge ratios and rebalancing their positions (see our earlier discussion of dollar hedging). This was the central focus of trading during the first several months of the dollar’s decline, and it is why we chose the euro as our core trading pair for a time: the euro is the key proxy in dollar-hedging trades.

But Over the past two weeks, the link between the dollar and interest rate expectations has strengthened again—especially as markets have repriced bets on Fed easing.This means If the Fed begins a genuine rate-cutting cycle in the coming months—for example, starting in 9 and continuing to cut rates through the year—that would be a key catalyst for the dollar’s depreciation trend to “continue advancing.” Conversely, without such rate declines, the dollar could fall into the kind of “fairly flat, gradual downtrend” often seen in history.

A consistent dollar depreciation trend hinges on whether, starting today, the Fed pushes short-term rates lower and narrows the rate differentials with other economies.

Whether the market follows the trading path of 1985 or that of 2009, we have now reached a key juncture.

4. So, against the backdrop of a genuine shift by the Fed toward easing, which asset classes would benefit the most?

Chart: Weekly Wrap 250629

Fed easing is generally positive for emerging-market assets, Even without actual rate cuts this year, EM assets have had one of their strongest starts in recent years: EM local-currency bonds have posted double-digit gains, and EM stocks have risen nearly 15% in the first half.

This shows that structural support is already very strong even without help from the Fed. Adding the possibility of Fed rate cuts now would create an almost perfect tailwind for emerging markets.

Likewise, from an allocation perspective, if the global cycle remains resilient and the Fed cuts rates because inflation is moderate or its reaction function changes, more cyclical EM assets should also perform best, such as EM equities and high-yield currencies. These assets often perform very well in a “strong cycle + Fed easing” environment.

Chart: Weekly Wrap 250707

If Fed rate cuts coincide with “growth remaining resilient,” the Korean won would stand out. As a low-interest-rate economy, South Korea and its currency would be a central focus in a potential dollar-downturn cycle in the second half. Pairing the won with Korean equities is a good approach, especially given domestic catalysts such as current improvements in corporate governance.

Even against a backdrop of relatively weak growth, Fed rate cuts would still benefit low-yielding EM currencies such as Asian export-oriented economies—the decline in U.S. short-term rates will change these economies’ foreign-exchange balances and hedging structures. Likewise, from the perspective of local rate markets, Fed rate cuts would provide more policy space, especially in a combination of “a weaker dollar + lower oil prices + falling inflation,” giving the central banks of EM more room to act.

Finally, an old favorite: the Brazilian real and Brazilian equities:

Chart: BRL

Chart: Brazilian equities

2025.07.07

The soft-landing scenario

At the end of last week, we briefly commented on the U.S. employment report. Since it was part of a discussion alongside currency positions, the focus was mainly on foreign exchange. Today, we’ll broaden the focus and discuss the scenario of a moderate cooling in the U.S. economy behind the data.

To sum it up in one sentence:This is a better than the market’s pessimistic expectations employment report, but cannot be called “strong”..，Behind data that still look acceptable overall, the report does show some signs of weakness.

1) The market’s first focus is job growth:Government accounted for nearly half of this month’s job growth, and most of these government jobs were concentrated in hiring by state and local education systems. Our assessment is that There may be seasonal distortions in this, which means the data could show a payback effect in the coming months, with some of these new jobs being reversed.

2) If we exclude government and look only at private-sector job gains, they do show that growth continues to slow:From a seasonal-adjustment perspective, job growth will also face greater challenges in the coming months, so the overall nonfarm payroll figures are unlikely to be as strong as they were in recent months.

3) But This slowdown is not necessarily cause for concern This is because the labor market’s current break-even rate of employment growth—that is, the minimum number of new jobs needed to keep the unemployment rate stable—is declining. A key factor behind this is slower immigration and, consequently, slower labor-force growth.

Chart: Weekly Wrap 250608

This means, As long as monthly job gains remain around the trend level of 10 ten thousand, that would be enough to keep the unemployment rate at its current level.The household survey also shows a slight decline in the unemployment rate, indicating that despite slower nonfarm payroll growth, the situation is not serious from the perspective of unemployment.

Overall, this report does not look good, but it is not terrible or worth panicking over. Taking both the headline data and the structural weakness into account, this is not a report that surprises to the upside, but it is not the disastrous employment data the market feared either.

For the Fed, the most direct implication of the data is that it rules out the tail risk of an emergency rate cut in 7.

In other words, this report is enough to dispel the possibility of being forced to cut rates in 7 because of a collapse in employment data. Whether rates are cut next will depend entirely on the combined performance of all upcoming economic data. This also means that markets and the Fed will continue to monitor the interaction between employment reports and inflation data, rather than making a judgment based on a single data point.

This is still a process of moderate cooling, not a scenario of rapid deterioration.

Chart: Unemployment-rate dynamics and credit assets

However, It is worth noting that there is a logical possibility that the Fed’s rate-cut path could start earlier and accelerate:

Based on the tariff effects that have materialized so far, the monthly data showing their pass-through to inflation have been noticeably milder than expected, easing our concerns about inflation persistence.Even with tariff-related disturbances, the absolute magnitude of inflation is not excessive, allowing us to turn our attention to other components of inflation.

As for core inflation, once tariff effects are excluded, underlying inflation has fallen materially, and major indicators such as housing inflation have returned to levels consistent with the 2% target.Therefore, if the tariff effects are absorbed by the market and underlying inflation also moderates significantly, policy-rate normalization—that is, the start of rate cuts—could begin earlier.

In this environment, the Fed has reason to return to the neutral rate more quickly. Combined with signs of a slowing labor market, the picture as a whole still supports a path in which rate cuts begin in 9, even though the nonfarm payroll report slightly reduced the urgency to cut.After all, a lot of data will be released between now and 9, and a marginally softer inflation reading and slightly weaker employment would be enough to bring this path about—the specific ways this could happen are varied.

An addendum at the end, about the data:

ADP is very poor at forecasting nonfarm employment... mainly because nonfarm employment itself does not reflect actual changes in employment very well.

2025.07.07

III. Market Pulse 

Our latest Comments on the economic and market environment

Note: All content in this text is for reference only, does not constitute investment advice, and is not a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for decision-making.