Volatility Surges Amid Economic Uncertainty
US stocks are on course for their weakest start to a presidential term since 2009, weighed down by recession fears and lingering uncertainty surrounding tariffs. The Nasdaq 100 plummeted by as much as 4% on Monday, marking its worst day since 2022, while the S&P 500 extended its decline from a record high to 8% and closed below its 200-day moving average for the first time since November 2023. Benchmark US Treasury yields tumbled as expectations for Federal Reserve (Fed) interest rate cuts increased, while the US dollar index steadied following its worst weekly performance in two years.
US President Donald Trump’s shifting stance on tariffs has been unsettling financial markets for some time. More recently, concerns have intensified that policy uncertainty could push the US economy into recession. In an interview over the weekend, Trump refused to dismiss the possibility of an economic downturn, brushing aside business concerns over a lack of clarity regarding his tariff policies. This has fuelled speculation that his administration is willing to tolerate short-term economic hardship in pursuit of longer-term objectives. Amid the uncertainty surrounding trade policy, persistent inflation, and the uncertain trajectory of the Fed’s interest rate easing cycle, investors should prepare for continued market volatility. The VIX index, a key measure of anticipated volatility in the S&P 500, has already surged to its highest level since December. While implied volatility in the currency markets has risen, it remains well below the peaks seen in 2022 and 2020.
The fundamental principles behind Trump’s economic plan of deregulation and tax cuts were expected to support the dollar. However, the implementation of his tariff policies has soured market sentiment, turning the outlook for the dollar negative. In the very short term, a consolidation phase or a slight rebound may be possible following last week’s turbulence, but it is likely that we have already seen the peak of dollar strength for 2025. Attention now turns to today’s US JOLTS job openings data, followed by inflation figures on Wednesday, which will be closely scrutinised.
A Defining Moment for the Euro
Following its strongest week since March 2009, EUR/USD’s momentum appears to be losing steam, with the pair now residing in overbought territory on the daily chart. Nevertheless, today’s high of $1.0875 is nearly five cents higher than where it traded just a week ago. A short period of consolidation may precede another upward movement, but several bullish factors remain in play.
As previously reported, the European Union plans to amend fiscal regulations to allow for increased government spending, which has driven bond yields higher across Europe while also bolstering optimism regarding economic growth in the region. A report suggesting that Germany’s Green Party is willing to negotiate and foresees an agreement on defence spending by the end of the week has reinforced this narrative. Further impetus may come from potential US-Ukraine negotiations on Wednesday and additional details on EU member states’ plans to increase defence spending, including support for Ukraine. However, short-term enthusiasm could be premature, given the slow transmission of expansionary fiscal policies into economic growth and the European Central Bank’s (ECB) policy response. Moreover, the possibility of a trade war targeting Europe remains a risk. As a result, further gains for the euro will likely depend on continued signs of economic slowdown in the US. One thing is certain, though: the divergence between US and European economic trajectories is set to drive increased foreign exchange market volatility.
With no major economic data releases from Europe today, attention will turn to comments from ECB officials. Following last Thursday’s interest rate cut, markets are now pricing in only one additional quarter-point reduction in 2025, which would bring the ECB’s deposit rate to 2.25%. Just a week ago, expectations had been for the rate to decline to 2% by December.
Sterling Tests Key Support Against the Euro
This morning, the pound is testing its 50-week moving average against the euro, a key support level. A break below this threshold could pave the way for a move towards €1.1740, as the gap between German and UK bond yields narrows and expectations for stronger Eurozone growth rise in light of Europe’s expansive fiscal plans. Meanwhile, GBP/USD has struggled to gain further traction, hovering near the $1.29 level following last week’s significant 2.7% rally.
With US recession risks on the rise, sterling suffered its biggest losses against the Japanese yen yesterday, as heightened risk aversion drove demand for safe-haven currencies. Although the UK is in a comparatively better position to avoid US tariffs due to its goods trade deficit, the pound remains vulnerable via the risk sentiment channel. This is largely due to the UK’s deteriorating net international investment position and persistent current account deficit, making sterling dependent on foreign capital inflows, which often diminish in times of market turbulence.
On the macroeconomic front, data released early this morning showed that UK retail sales grew by just 0.9% year-on-year in February, a sharp slowdown from January’s 2.5% increase and well below the expected 2.4% rise. Consumers have continued to rein in spending amid the ongoing cost-of-living crisis. Later this week, UK GDP figures will be in focus for sterling traders.
