top of page

Turn that Frown Upside Down (USD Smile)

25 June 2025


One of our mentors used to say, it’s important to think symmetrically about risk. Iran attacked a US military base in Qatar overnight in a symbolic gesture to de-escalate. Trump then announced a “complete and total” Iran-Israel ceasefire. Iran later said that there is no formal agreement yet, but it will hold fire if Israel halts its attack. Oil declined by 11% and the dollar index depreciated 1.2% from Monday’s high. The good news is that this might have removed the tail-risk of the closure in the Strait of Hormuz and an impulsive spike in oil above $120. The bad news is that the conflict in the Middle East is not the only risk factor for markets.

 

Tariff off-ramps have also reduced the perceived tail risk to macro (growth downside and inflation expectations). However, there are two key points to note. First, the tariff deals are yet to be completed with the early July deadline approaching fast. Second, tariff risk has largely been priced out judging by the equities most at risk. A UBS basket of tariff losers is back to the April 2nd level (chart 1).


Chart 1

Source: Bloomberg


At the June FOMC Meeting last week the Fed revised down growth and revised up inflation. While the interest rate markets have priced 50 basis points of cuts by year end, the path of rates could change depending on how the data evolves. The Fed Chairman indicated that increases in tariffs will likely boost prices. The fiscal impulse might remain firm under the proposed “Big Beautiful Bill” providing upside risk to inflation. US fiscal policy has been at “emergency levels” for some time despite the economy operating at full employment. Both factors have probably contributed to a rise in Treasury yields and the term premium.

 

While inflation expectations are elevated, there has been a deterioration in both the Citi US economic surprise index and the labour market under the surface (chart 2). That likely explains recent weakness in the dollar. However, our sense is that short/underweight US dollars is a crowded consensus belief and vulnerable to reversal despite the tension on the dollar’s haven status and portfolio flows. Has the dollar smile become a frown?


Chart 2

Source: Bloomberg


As we noted last week, although the unemployment rate remains low, partial indicators of the labour market (job openings, temporary hires, monthly revisions, and layoffs) undercut the “resilient labour market” narrative. The Challenger layoffs time series now rival those from September 2008 right before the systemic rupture went mainstream. The data might indicate fragility under the surface: where headline strength masked a rolling deterioration. Just like in 2008, we may be mistaking lagging indicators (like the unemployment rate) for structural health, when leading indicators (job cut announcements) are screaming stress.

 

There is also a tension or divergence between the US dollar and Treasury yields (chart 3). The good news for bond investors is that if there is a sharp deterioration in growth over the coming months it would likely undermine inflation expectations. Put another way, the “good outcome” for debt sustainability (bond demand) is a recession. The bad news is that the risk-reward in equities and credit is poor in that scenario. As we have noted, the S&P500 (global risk proxy) trades at 22 times forward earnings or in the 86th percentile of the 30-year valuation range. Equity and credit volatility tends to rise in a recession as the cash flow and profit cycle deteriorate. Of course, we don’t know if this will be the outcome. What we do know is that risk compensation is poor given the deterioration in some of the key leading indicators and policy risk. The potential ceasefire today takes out one tail risk, however trade tensions and domestic growth challenges remain. In that context, the risk-reward in US equities is not very attractive.


Chart 3




























 
 
 

Komentarze

bottom of page