Optimism Over Trump’s Tax Plans
US stocks closed at a five-week low yesterday, while bonds surged, as another disappointing reading on the US consumer heightened concerns about the health of the world’s largest economy. The US dollar index also retreated after Treasury Secretary Scott Bessent indicated that US yields and the dollar would decline further due to Trump’s policies, even if the Federal Reserve (Fed) kept interest rates on hold. However, both the dollar and Treasury futures reversed course after House Republicans passed a budget blueprint, paving the way for $4.5 trillion in tax cuts.
The fluctuations in macroeconomic and political developments are keeping investors on edge, leading to volatility in financial markets. Concerns over economic growth in the US deepened on Tuesday when a closely watched measure of consumer confidence suffered its steepest decline since August 2021, reflecting uncertainty about the broader economic outlook. This prompted traders to increase bets on Fed rate cuts this year, despite signs of mounting inflationary pressures. Treasury yields fell to their lowest levels in 2025, while a gauge of megacap stocks extended its decline from its peak to over 10%. Meanwhile, Bitcoin and the wider cryptocurrency market suffered substantial losses, and the US dollar index closed below its 100-day moving average for the first time since October 2024. Many of these sharp movements appear to be a reversal of the "Trump trade" narrative, with growing concerns over weakening US consumer activity bolstering expectations of Fed policy easing.
However, the proposed tax cuts have halted the decline in equities and the dollar, while Treasuries have stabilised. Republicans have defended the cuts, arguing they will stimulate economic growth and, alongside other Trump measures such as tariffs, help contain the deficit. The renewed focus on fiscal policy could temporarily support the dollar and divert attention from weak consumer activity—at least until tariffs take centre stage again next week.
Euro Struggles at $1.05
The euro has posted a notable recovery against the US dollar in February, having rebounded from a more than two-year low earlier in the month. EUR/USD has climbed roughly 4%, rising from near $1.01 to testing the key psychological resistance level of $1.05, though it remains six cents below its five-year average.
A cyclical downturn in the US dollar has played a significant role in this rebound, with soft US economic data disappointing investors and aiding the euro’s recovery. However, fundamental economic indicators in the US remain relatively robust. Reports of a possible peace agreement in Ukraine have also provided modest support to the euro, primarily through increased military spending due to heightened security concerns, as well as lower gas prices easing energy cost pressures. Meanwhile, tariff fatigue has allowed risk appetite to improve, further benefiting the pro-cyclical euro. However, while the outcome of Germany’s recent election has provided some relief, it has yet to deliver a meaningful boost to the currency.
Stability in bond markets has also failed to lift the euro. The typical inverse relationship between EUR/USD and the MOVE index (a measure of fixed income volatility) diverged around the US election. The index has since declined by approximately 16% and is now trading near its lowest levels since early 2022. Under normal conditions, such a move would be expected to push EUR/USD above $1.10.
Yet, foreign exchange markets are driven by a multitude of factors, and their relative influence fluctuates over time. EUR/USD’s recent difficulty in breaking decisively above $1.05 suggests that expectations of a sustained rally may hinge on a more pronounced downturn in the US economy, the timing of which remains uncertain.
Sterling Lacks Fresh Catalysts Against the Euro
Sterling rallied to near its highest level of 2025 against the euro last week and remains more than two cents above its year-to-date low of €1.18, well above its five-year average of €1.16. GBP/EUR has maintained a steady upward trend for the past two years, experiencing only six months of modest declines over this period and gaining nearly 8% overall. While there are reasons to anticipate further gains in 2025, the lack of a fresh positive catalyst could limit sterling’s upside potential.
While excessive euro pessimism appears to have stabilised, the broader European economic and political backdrop remains unfavourable for the currency. Although the UK economy is projected to grow by approximately 1% this year, recent data has been relatively encouraging. In contrast, the Eurozone is expected to expand by around 0.9%, with increased US protectionism weighing on growth prospects in both regions. If and how President Trump implements his tariff threats remains uncertain, but under most scenarios, the UK is likely to be less affected than the Eurozone, given that a significant portion of UK exports to the US are in services. Political uncertainty is also higher across Europe compared to the UK, though Germany’s election outcome has raised hopes for pro-growth structural reforms in Europe’s largest economy.
The most significant factor supporting GBP/EUR is interest rate differentials. The European Central Bank (ECB) is expected to implement deeper interest rate cuts than the Bank of England (BoE) this year, given the UK’s still-elevated wage growth and services inflation. However, much of this expectation is already priced into the exchange rate, and real interest rate differentials (accounting for inflation) suggest that €1.19 is a fairer valuation.
What does this mean for the future of sterling against the euro? Absent any major shifts in the outlined fundamentals—slightly stronger UK growth, reduced political uncertainty, and fewer BoE rate cuts—GBP/EUR should remain supported, with no major trend reversal anticipated in the near term. However, the currency pair continues to encounter resistance around €1.21, which marks the upper limit of its post-Brexit trading range since 2016. A decisive breakout above this level would be necessary to establish a new higher trading range.
