Macro Views: Optimism at the edges

• Policy easing to resume: Fed Chair Jerome Powell set the stage for a resumption of policy easing to occur at the September FOMC meeting, citing rising downside risks to the labor market. While the August jobs report supports this view, most economic data released since mid-August have largely surprised to the upside. Financial conditions have eased to mid-2020 levels. Inflation data, while stable, shows signs of persistence in non-housing services and input prices, indicating that the case for easing rests squarely on the perceived risks to employment.

• Labor market slack is building, but it’s not all gloomy: While the unemployment rate remains relatively stable, hovering just above 4%, there is an uneasy equilibrium in the labor market. The low-hiring, low-firing dynamic has kept the unemployment rate from rising sharply, but it also masks underlying fragility. Long-term unemployment has hit 1.93 million—it’s highest since 2017 (outside of the pandemic)—and more people outside the labor force now want jobs. Employment in the goods sector has contracted for four straight months, often a leading indicator of broader weakness. Yet not all indicators are negative. The Conference Board’s jobs differential remains more favorable than in the post-global financial crisis or mid-2000s periods. The New York Fed’s labor market survey reveals a post-pandemic high in job-leaving rates, suggesting continued confidence among workers. Despite the slowdown in labor demand, wage growth has remained above 4% for the past year. Interestingly, wage growth has eased for lower-income groups, implying that tighter immigration has yet to translate into higher wages for low-skilled workers. Meanwhile, the reservation wage—the minimum wage workers are willing to accept—has begun to rise again, suggesting that there may yet be scope for wage-driven inflationary pressures.

• Cautiously optimistic on economic activity: July spending data confirmed that the “payback” from tariff front-running abated as spending rebounded, especially in durable goods, supported by real income gains. This is significant because, like goods-sector employment, durable goods are typically the first category to show signs of cooling. However, tariff-inflation and reduced transfer payments may soon pressure lower- and middle-income households. Corporate profits remain resilient, but margin pressures are rising due to significant tariff-related costs. Many firms are reportedly renegotiating supplier terms, restructuring supply chains, and/or passing increased costs on to customers. Meanwhile, corporate concerns over wage pressure have eased and the probability of layoffs remains limited. Regional Fed surveys show a gradual recovery in firm capital expenditure (capex) intentions, corroborated by rising new orders and imports for capital goods. A sharp upward revision to intellectual property investment in the second estimate of the second quarter GDP likely reflects a lift from enterprise spending on generative AI products, suggesting that firms are actively investing in productivity enhancing measures.

• Inflation in transition; risks to the upside: Shelter inflation is easing and will likely continue to do so in our view, but non-housing core services inflation has begun to reaccelerate. The latter is a key area of concern since elevated wage inflation could continue to drive up prices in the most wage-sensitive parts of non-housing core services. Immigration constraints may exacerbate this issue. With goods inflation, the bulk of the tariff impact is likely still ahead of us. A large share of US imports remains duty-free and with importers reducing purchases from high-tariff countries; actual tariffs paid were just over 9% as of June compared to a theoretical rate of 16% based on 2024 import levels. We expect this gap to narrow in the months ahead. Producer prices may well be starting to reflect tariff impacts, and if they continue outpacing consumer prices, corporate profits may weaken, prompting firms to scale back hiring or even consider layoffs.

• Fed policy: Market are anticipating a 25-basis-point interest rate cut in September, followed by another in December. However, rising tariff-driven inflation may limit further easing. In our view, the scope for meaningful declines in short-dated Treasury yields appears limited since Fed policy expected to normalize rather than turn overtly accommodative over the next year. Moreover, the bar for the Fed to signal a more aggressive easing stance remains high. At the long end of the yield curve, although term premium narratives have taken a backseat to near-term Fed policy expectations, the overall level of term premium remains elevated. Looking ahead, we expect term premium to rise, with the possibility for some bear steepening. Powell’s shift toward labor market support over strict inflation control could reduce recession risks and fuel stronger growth and inflation, pushing yields higher. Additional upward pressure may come from weaker immigration and a more dovish Fed, as US President Trump could have four appointees to the seven-member board as early as next spring.

• Lackluster growth in the short-term, but economic revival through fiscal stimulus: Cautious optimism characterizes our medium-term outlook for the euro-area (EA), due to the expected impact of Germany’s fiscal stimulus, which the market appears to be under-appreciating. Germany’s draft budget in June announced sizeable fiscal spending (amounting to approximately 20% of 2024 GDP) over the next four years, with significant front-loading expected. However, headwinds persist in the near term. The overall growth trend across the euro-area remains sluggish, with inventory building largely driving second-quarter growth [0.1% quarter/quarter (q/q) and 1.4% year/year (y/y), with growth]. Although exports were a negative contributor (-0.5% q/q), the payback from the front-loading of trade in the first quarter was lower than expected. More striking was the slowing in private consumption and in investments in the largest four EA economies (Germany, France, Italy and Spain), attributed to uncertainty and low confidence amid trade-related uncertainty.
• Modest business optimism versus timid consumers: Nonetheless, leading indicators, such as business surveys, have shown improvement. The composite Purchasing Managers’ Index of manufacturing rose to a 3.5-year high in August. This trend is also being reflected in a clear improvement of the expectations component of the German Ifo index, driven by an expected positive impact from fiscal stimulus. In contrast, consumer confidence surveys remain weak, despite a modest pickup during the first quarter that has since flatlined. Consumers remain reluctant to spend, with savings still above pre-COVID-19 levels. As confidence returns, a high savings rate coupled with real income growth should support consumption over the medium term. 
• ECB—not overengineering monetary policy: As expected, the ECB left the policy rate on hold at its September meeting (at 2.00%) in a unanimous decision. The overall tone of the press conference was broadly unchanged from July, reiterating that the ECB is "still in a good place" but "not on a predetermined rate path." A few hawkish tones were struck on the outlook and inflation. Growth risks are now seen as more balanced compared to July, mostly due to the US-European Union (EU) trade deal, which supposedly eliminates the risk of higher tariffs and EU retaliation risks (which we were always skeptical about). Regarding the near-term outlook, policymakers held a sanguine view of the growth trend in the first half of 2025. On inflation, the ECB noted that "the disinflationary process is over" meaning that most of the moderating forces from previous years will normalize. However, wage growth is expected to decline further, with labor markets expected to remain stable—a fundamental assumption of ECB policymaking.
• The ECB updated its June growth and inflation forecasts. Growth in 2025 was revised higher to 1.2% from 0.9%, while the 2026 forecast was lowered to 1% from1.1%. Contrary to our expectations, the German frontloaded fiscal stimulus growth impact was not revised higher following the draft budget of late June. In our view, the potential impact has been underestimated. Meanwhile, inflation forecasts were revised down slightly, including confirmation of the undershoot in 2026.  In post-meeting comments, President Lagarde expressed that the ECB would not react to minimal inflation deviations from the target, assuming they remain small and temporary.
• Overall, we do not envisage further rate cuts unless growth or inflation materially disappoint over the next six months, with the window for easing progressively narrowing as the German fiscal impulse should become more visible in 2026.
• Rates—front end can steepen further, long end support will remain limited: The front-end of the yield curve has been well anchored since post-Liberation Day, with investors pricing out some easing after the ECB's July meeting. There is scope for the curve to steepen in the 1–3-year sector as the German fiscal impulse becomes more tangible. Longer-dated maturities are likely to remain under pressure amid a broader global move and local drivers. As well as higher supply from Germany, anticipated Dutch pension reforms that are due to come into effect in January are expected to weigh on demand. 

• Growth—the resilient economy underscored by second quarter GDP numbers: The Japanese economy showed resilience in the second quarter 2025, with GDP growth rising by 0.5% q/q and 1.7% y/y. Private consumption and overall investment were solid, offsetting a flat public spending. Exports were strong, adding to growth, while imports were slower, resulting in a positive contribution to growth from net trade. Despite concerns over tariffs, Japanese firms, especially in the auto sector, managed to maintain export volumes by squeezing export prices. However, the third quarter is expected to see a slight decline in GDP due to adjustments in export prices and the impact of amendments to the Building Standards Act on private housing investment.

• High-frequency indicators suggest a modest deceleration in growth for the second half of 2025, with large manufacturers' sentiment improving and consumer confidence rising but the outlook worsening. Yet, services, which account for nearly 70% of GDP, continue to drive the economy forward, supported by a rebound in tourist flows. Despite a slower third quarter, we expect full-year growth should remain solid at 1.1% y/y.  Prime Minister Ishiba’s resignation paves the way for some political uncertainty over who the leader will be and how the fiscal package shapes up. These will be crucial not only for the economy but also for asset prices.

• Inflation—the curious case of rice inflation: The headline consumer price index (CPI) remained strong at 3.1% y/y and core CPI (excluding fresh food) also at 3.1% y/y. Government subsidies have been distorting actual inflation, but underlying inflationary momentum remains strong. Food prices, particularly rice, continue to drive overall inflation, with manufacturers passing on higher costs to output prices. The Tokyo Ku area CPI showed a slight decline in August, but overall inflationary pressures persist. Weekly retail rice prices are again ticking up (chart below) after a dip in June-July indicating that prices are stickier and taking longer to revert to normal despite the government’s measures of releasing stockpiles. Sustained food inflation (especially of staples) can lead to inflationary expectations becoming more entrenched in households, a risk the BoJ has flagged earlier.

• BoJ—gradual tightening to continue: The BoJ is expected to continue its gradual tightening trajectory, with a 25-basis-point rate hike anticipated in October and at least three more in 2026. Wage growth progression and the stickiness of food inflation are key factors likely to influence the BoJ's future rate decisions. Despite long-end yields reaching record levels, we think the outlook for Japanese Government Bond (JGB) yields remains bearish due to fiscal expansion uncertainties until clarity emerges on Prime Minister Ishiba’s successor.

• Overall, forecasters generally expect the Japanese economy to maintain resilient growth in 2025 and 2026, with GDP averaging 1.1% y/y in 2025 and slowing slightly to 0.8% y/y in 2026. Inflation is forecasted to remain above 3% for the rest of 2025, driven by high food prices and gradual but persistent services prices.

Currency outlook

US dollar (USD)

• After a period of significant depreciation earlier this year, the dollar stabilized and has begun to realign with traditional cyclical drivers. Although the US Dollar Index (DXY) continues to trade at a discount to the weighted two-year rate differentials, the gap has narrowed. Our analyses confirm that short-end US yields have become more influential than global equities or commodities in shaping USD movements. This marks a departure from the earlier dominance of structural and policy uncertainties. Moreover, the sharp narrowing of the goods deficit, which bodes well for the current account position, and foreign investors’ return to US assets, particularly US equities, since April imply reduced balance-of-payments pressure on the USD to weaken.

• However, despite these improvements, it may be premature to conclude that the dollar has bottomed out. The United States continues to run twin deficits—a fiscal deficit of around 6.5% of GDP and a current account deficit near 4%—both significantly worse than in 2018–2019. These imbalances could undermine the dollar’s attractiveness, even with its interest rate advantage. Moreover, the US’ yield advantage is expected to fade over time as the overall direction of monetary policy is geared toward easing. By mid-2026, the Fed is expected to be the only G10 central bank still easing policy, while others begin tightening. Relative growth has historically been of greater significance to foreign exchange markets, and although US economic growth has remained resilient, its relative performance compared to G10 peers is expected to become less exceptional. Additionally, Deutsche Bank’s research suggests that the curvature of the yield curve—not just the level of short-term rates—can significantly influence currency markets. A flattening of the curvature—where medium-term rates fall faster than short-term ones—signals weaker growth prospects and can deter capital inflows, which in turn is bearish for the USD.

Euro (EUR)

• Fundamental and technical factors remain supportive of further euro appreciation, in our view, albeit relatively contained compared with its strong performance since March. As well as the cyclical support from an improving macroeconomy, structural trends remain in place that we believe should further underpin the euro: the increasing market size of the European Government Bonds (EGBs), rising credit quality, tighter sovereign spreads, and historically attractive yields.

• On the demand side, international investors are driving flows for euro-denominated assets, although this trend is more evident in fixed income rather than equities. ECB data for the second quarter showed that non-EA investors bought a significant amount of EGBs. Despite a rise in interest from EA debt securities from the rest of the world, repatriation from the United States has been marginal. This is mostly attributable to ongoing EA purchases of US stocks, while being a net seller of US Treasuries. While investors positioning remains undoubtedly overweight the EUR, markets seem to underappreciate narrowing growth differentials with the United States in 2026.

Japenese yen (JPY)

• Our broad call for a stronger yen in the medium-term remains unchanged. But we remain more on the sidelines in the near term. There are factors on both sides (yen and dollar) that are preventing USD/JPY from breaking lower, but we continue to believe that it is inevitable partly because of the yen’s cheap valuations.

• Several factors are liming the yen’s strength in breaking out of current levels: the BoJ’s muted responses or forward guidance on further tightening, domestic political instability and the uncertainty over the new Prime Minister and government’s fiscal policies as well as extended short USD/JPY positioning despite recent correction. Until positioning adjusts materially, it will be hard for the yen to capitalize on dollar weakness (as we have seen in recent months). Technically, a Fed cut coinciding with a BoJ hike would be crucial for USD/JPY to trend materially lower, in addition to positioning adjustments. But for now, we believe domestic political and fiscal risks will limit a clear pivot in that direction.