USD: Deficit concerns and tariff drama hangover can bite - ING

We shouldn't be surprised to see the dollar softer at the start of the week, even with US President Donald Trump reversing course on 50% EU tariffs. It's not a case of the greenback suddenly rediscovering its safe-haven status - by most measures, it hasn't - but more a reflection that markets had largely filed tariffs under 'April risks'. The focus for May and beyond was supposed to be on trade deals. Admittedly, some agreements were always going to take time, and the EU never looked like an easy one. Still, the renewed standoff between Trump and the EU is a reminder that tariff threats and delays can re-emerge quickly. If there's a lesson from April, it's that the dollar bears the brunt of tariff drama, ING's FX analyst Francesco Pesole notes.

DXY more likely to retest the 98.0 April lows

"Our short-term fair value model, which looks at the past year's FX correlations with rates and equities, still points to the dollar being highly undervalued: around 4% versus the euro, sterling and Canadian dollar, 3% versus the Japanese yen and Aussie dollar. But for now, we have to set that aside; the greenback still isn't trading in line with the classic market drivers. In many respects, it's behaving more like an emerging market currency, where investors are fixated on public finance sustainability, watching capital flows closely, and forced to factor in unpredictable policy moves. The decoupling is clear - the 60-day correlation between 10-year Treasury yields and DXY started the year at 0.68, and now sits at zero."

"For now, the best hope for the dollar is that incoming data calms recession worries. That's needed, as deficit concerns are starting to shake the dollar's already fragile footing. It's not so much that Trump's spending bill blows out the deficit overnight, but more that this was a rare opportunity for Congress to address the deficit issue, and it's been missed. The risk is that US creditworthiness worries remain a drag into the summer, as Treasury auctions could still point to lukewarm demand."

"FX liquidity was thin on Monday due to a US and UK public holiday. Today, we'll get a better sense of direction. Our view is that the balance of risks remains skewed to the downside for the dollar due to deficit concerns and trade uncertainty, unless US data comes in convincingly stronger than expected. A retest of the 98.0 April lows in DXY looks more likely than a rebound to 100.0 at this point."