The US Goverment may open again

FX volatility has been tumbling since the tariff-related spike back in April. One-month implied volatility in the dollar index, the DXY, is now around half of the level seen in April and, at just over 6%, is the lowest in over a year. While the absence of US government-generated economic data releases cannot be blamed for all of this slide in volatility, it seems to have had some bearing just recently. Once the government is up and running again, the data will return, and it might return in a way that weighs on the US dollar. This is because many analysts suspect that the data will show a weaker real economy with more elevated inflation.

In the absence of government-generated data, the market has been left with data produced by the private sector, much of it survey-related, such as the ISM survey or consumer confidence. This already seems to be showing the economic cost of the shutdown, as the gap between positive eurozone data surprises and those in the US has surged in recent weeks. Of course, this not only reflects the fact that US data surprises have often been poor, but also that those in the eurozone have been positive.

Indeed, if we look across countries, it seems that the adverse hit from US tariffs is not as bad as feared. As US government-generated data starts to return, we may find that these data surprises not only show more economic weakness in the US but also prove more market-moving than private sector data, especially key numbers like US non-farm payrolls.

Steven Barrow, Head of Standard Bank G10 Strategy, said the data should help produce another 25-bps rate cut from the Fed on December 10th and, while that might have been expected to pass off unnoticed by the FX market a few weeks ago, the fact that Fed members have suggested that a cut is not a foregone conclusion may mean that there will be more FX sensitivity to the outcome. Of course, this could mean a notable rise for the US dollar should the Fed hold off from cutting rates, but we do not think it will do this because the data are likely to support the case for lower rates.

Perhaps, at a similar sort of time, we will hear the US Supreme Court’s decision about the legality of tariffs. While its verdict will not impact all tariffs, and although the Administration has other routes to take tariff action, we do think there could be an adverse dollar reaction. One reason for this is the US judges’ comments about the tariffs that were made during verbal arguments from both sides last week. As we see it, there are essentially two grounds on which the judges could uphold the illegal verdict that has been reached in more junior courts.

The first is that President Trump cannot claim that there is an ‘emergency’ in US trade, something that is necessary to enact the so-called International Emergency Economic Powers Act (IEEPA). But if the tariff case is lost on this basis, it is assumed that Trump will use one of a number of other avenues at his disposal to re-engage tariffs, such as Section 232, which cites national security as the justification. Hence, tariffs would effectively stay in place, just under different legislation.

However, there’s a second aspect of tariffs that seemingly troubled some judges more than the use of IEEPA. It is that the Constitution delegates general tax-raising authority to Congress, not the president, and with tariffs likely to raise up to USD500bn per year, according to Treasury Secretary Bessent, it seems clear that they are a significant tax-raising tool. If this proves to be the basis for Supreme Court rejection, it could cast a pall over other tariff legislation that Trump might try to use to replace the IEEPA, and that, in turn, could cast a pall over the US dollar.

But while US dollar bears could see a trifecta of ‘wins’ before year-end in terms of weak US data, a Fed rate cut, and a Supreme Court defeat for the Administration, these outcomes might come too late in the year to bear down heavily on the greenback. “The Supreme Court ruling, in particular, could occur very late in the year when market activity is limited and so take away much of the FX market’s ability to respond. Of course, there is a flipside, which is that low liquidity could exaggerate any slide in the dollar, although we prefer the first scenario that talks to a muted market reaction,” said Steven Barrow.