Tariff Delay Hopes Lift US and European Equities

Relief at the prospect of US President Donald Trump delaying tariff plans has propelled equities in the US and Europe towards record highs. The US dollar has weakened this week, but this may represent a short-term correction rather than a lasting trend change, as investors continue to deliberate over the timing of Trump’s tariffs. On Wednesday, EUR/USD reached a five-week high, and GBP/USD hit a three-week high, though further gains appear limited in the near term. Upcoming preliminary PMI data from advanced economies, due on Friday, will be closely watched. Meanwhile, the Bank of Japan is anticipated to raise interest rates, which could lend support to the struggling Japanese yen, down more than 1% against both GBP and EUR this week.

Trump Targets China, Markets Shrug

Financial markets showed little reaction to US President Donald Trump’s renewed threat to impose 10% tariffs on Chinese goods at the start of next month, citing concerns over the US trade deficit with the EU. While “actual” market volatility remains subdued, “expected” volatility remains elevated, particularly in the foreign exchange market, with traders taking positions against CNY, CAD, and MXN.

Markets had been on high alert for sweeping tariffs, which were arguably priced into the strong US dollar. Some may view this as a textbook case of “buy the rumour, sell the fact.” Trump’s tariff rhetoric has impacted currencies such as the Canadian dollar and Mexican peso, yet both have returned to levels seen on inauguration day. It seems investors may have overestimated the immediacy of Trump’s trade policies. Without immediate catalysts for a major dollar rally, the currency may face further depreciation if Trump continues to underdeliver on tariff threats. However, it remains unclear whether this is merely a tactical dollar correction or the beginning of a broader trend reversal.

While many currencies gained 1% or more against the USD on inauguration day, they still have significant ground to recover after substantial losses since the US election in November last year. With tariffs merely delayed and disinflationary trends stalling, the Federal Reserve’s bias to cut rates may be weakening, which could sustain favourable rate differentials and provide ongoing support for the dollar.

Euro Hits Five-Week High – Breaking the Downtrend?

EUR/USD has risen nearly 3% since touching two-year lows last week, hovering around its 2025 level and poised for its largest weekly gain in over a year.

From a broader perspective, the euro remains about 7% below its 2024 peak of $1.12. While it seems to have broken out of its four-month downtrend channel, a close above the 50-day moving average at $1.0436 will be critical to confirming whether the pair can extend towards $1.05 in the short term.

What’s driving the euro’s recent strength? This appears to be more a story of US dollar weakness as investors respond to President Trump’s indication that tariff negotiations are possible. EU officials have echoed a willingness to negotiate, boosting global risk appetite and reducing the trade risk premium in EUR/USD, enabling the pair to climb. However, some market participants may be overly complacent, as the Eurozone remains vulnerable to potential US tariffs in the future.

The risk of EUR/USD falling below parity has diminished, but uncertainty remains high due to Trump’s unpredictability. Furthermore, growth and rate differentials continue to favour the dollar, making a sustained reversal in the dollar’s fortunes unlikely at this stage.

Pound Near Five-Month Low Against Euro

GBP/USD is up over 1% this week but remains trapped in a downtrend channel, trading two cents below its 50-day moving average and five cents below its 100- and 200-day moving averages. GBP/EUR, down more than 2% this year, is hovering near its five-month low of €1.18, having broken below its key moving averages earlier this month.

Increased global risk appetite this week, driven by uncertainty around Trump’s tariff plans, has boosted demand for riskier currencies. Sterling has gained against traditional safe havens like USD, JPY, and CHF. However, higher-beta currencies such as NOK, SEK, AUD, and NZD have outperformed the pound. The euro also remains resilient, but the downtrend in GBP/EUR may have limited momentum. Weak UK economic data suggests the Bank of England (BoE) is highly likely to cut interest rates by 25 basis points to 4.5% in February. The European Central Bank (ECB) is also expected to cut rates next week. While rate differentials do not currently favour a higher GBP/EUR, they may act as a stabilising factor against further significant downside for the pair.

As for GBP/USD, the pair is trading roughly 7.5% below its 10-year average of $1.32, which aligns closely with where UK-US rate differentials suggest it should be. While this is not enough to shift to a more bullish outlook for sterling, it could provide support if cyclical narratives in the US or UK begin to change.

Tariff Fears Weigh on Peso and Loonie

Investors were on edge yesterday as global markets began the week with a mix of optimism and uncertainty following Donald Trump’s inauguration for a second term. Reports and comments from the president himself about the United States considering steep tariffs on Mexico, Canada, and China sent ripples through financial markets, raising questions about how global trade dynamics might shift in the months ahead. Foreign exchange traders reacted swiftly, with the price of options products betting on further Canadian dollar weakness climbing to its highest level in two years.

In Europe, investors took some solace in the fact that no immediate tariffs had been introduced, though concerns about the future persist. Meanwhile, Chinese officials sought to reassure markets about economic stability as growth remains fragile. Despite these uncertainties, equity benchmarks across the developed world managed to edge higher, supported by robust corporate earnings, which helped offset fears surrounding trade policy. Longer-term bond yields continued to decline, offering welcome relief to currency markets, which had been contending with a stronger dollar until last week.

The US Dollar Index is already on track to decline for a second consecutive week, a trend last observed in September 2024. As the year progresses, markets are bracing for heightened volatility. With trade policy, central bank decisions, and geopolitical risks all in play, investors are navigating a complex macroeconomic landscape where any policy surprise could trigger sharp market movements.

Animal Spirits Push the Euro Beyond $1.04

Investor sentiment towards the European economy has been overwhelmingly negative, with fears of recession, weak growth prospects, and ongoing geopolitical risks dominating the narrative. However, much of this pessimism is already reflected in asset prices, creating an environment where the bar for positive surprises is exceptionally low.

This was underscored by yesterday’s ZEW investor survey, in which zero percent of participants described the Eurozone economy as being in good shape. The German sentiment index fell more than expected, remaining in deeply negative territory. This asymmetry in expectations means that any upside surprise in economic data—be it stronger-than-expected growth, resilient consumer spending, or even a modest improvement in business confidence—could provoke an outsized market reaction this year.

Such developments could have significant implications for the euro in the medium term. For now, however, its rally is being driven by market sentiment and dollar weakness, as investors respond to Trump’s decision to delay immediate tariff hikes. EUR/USD extended Monday’s gains, pushing beyond the $1.04 mark, with last week’s lows of $1.02 already fading into memory. Nevertheless, as the pair climbs higher, selling pressure is likely to increase, given the Eurozone’s continued vulnerability to potential US tariffs.

Sterling Still Stuck in a Downtrend

The British pound is currently 2% higher than its recent one-year low against the US dollar. Its recovery from $1.21 faltered just below the $1.24 threshold, leaving the downtrend that began in October intact. Although sterling has benefited from this week’s broadly weaker dollar, ongoing concerns about UK stagflation—characterised by persistently high inflation and stagnant economic growth—continue to weigh on the currency.

On Tuesday, data revealed that wage growth accelerated to a six-month high in the three months to November, aligning with expectations. However, the unemployment rate unexpectedly rose to 4.4%, alongside the steepest drop in payroll numbers since November 2020, hinting at potential softening in the labour market. While higher wages prompted traders to slightly scale back rate expectations, the likelihood of a rate cut at the Bank of England’s (BoE) February meeting remains above 80%. Sterling appears to be caught between a rock and a hard place. Its current negative correlation with rates and yields reflects concerns about the UK’s slowing economic growth and rising government debt burdens. Yet, stronger signals from the BoE about the need for interest rate cuts would likely further weaken sterling due to its impact on yields.

For the pound to stage a sustainable recovery against its peers, including the euro, UK economic data will need to show improvement alongside greater confidence in fiscal policy. This morning’s data, indicating that the UK government borrowed more than expected in December, highlights the significant challenges facing Chancellor Rachel Reeves.

Thin Liquidity, Strong Price Action

Recent headlines from The Washington Post and The Wall Street Journal, coupled with Trump’s recent call with Xi, have suggested that the new administration may adopt a more measured approach to tariffs than initially feared. The previously promised tariff hikes on day one of his presidency have not materialised. Investors welcomed the delayed tariff implementation, and while US markets were closed, futures trading and price movements in Europe and Asia reflected the positive sentiment with higher equity prices.

Although uncertainty persists, this development aligns with our initial presidential preview published in July, where we anticipated that Trump’s approach might not be as aggressive as markets had priced in. With no immediate catalysts to drive a significant rise in the dollar, market exhaustion could set in, especially if Trump’s policy stance and the Federal Reserve’s expected pause are already fully factored in.

However, Trump has made it clear that he will not entirely abandon his protectionist agenda. The president has announced plans to impose a 25% tariff on Canada and Mexico from 1st February. Whether this will actually be implemented remains uncertain. Nonetheless, this announcement was enough to help the dollar recover some of its earlier losses on Monday and to prompt a decline in equities. At present, uncertainty and volatility appear to be the only constants.

Fewer Reasons to Sell the Euro

The euro saw a significant rally against the US dollar, marking its best performance of the year so far. This upward movement was driven by reports that Trump would delay imposing new tariffs on his first day in office. These reports suggested that tariff hikes might go through Congress rather than being implemented via executive orders, alleviating immediate market concerns. With US markets closed for Martin Luther King Jr. Day, thin liquidity amplified the price movements.

While we maintain a mildly optimistic medium-term outlook for the euro, a repeat of its 2016 rally would require a more robust domestic macroeconomic backdrop. Meanwhile, currencies such as the Chinese yuan and the Mexican peso remain more vulnerable, given the potential for new export controls on China and stricter US immigration policies toward Mexico. The first few months of Trump’s presidency will be critical in shaping market sentiment. Should his protectionist bias dominate, volatility is likely to remain high. Conversely, a more pragmatic approach could lead to a repricing of risk across global markets.

Although Trump is expected to champion trade protectionism and economic nationalism, the key question is how aggressively he will pursue this agenda. The heightened uncertainty that once justified selling the euro is no longer a given, as much of the anxiety has already been priced in over the past four months. Monday’s price action, which saw a weaker dollar, could offer a glimpse of what’s to come in 2025 if Trump fails to deliver strong hawkish measures soon.

Pound’s Rebound Could Be Short-Lived

The pound experienced its best day of the year against the US dollar yesterday, buoyed by the news that Trump was holding off on his sweeping tariff plans. Higher-beta currencies—those more sensitive to changes in overall market or economic conditions—outperformed, benefiting more than traditional safe-haven currencies. As a result, the pound appreciated against the US dollar, Japanese yen, and Swiss franc but weakened against the Swedish krona, Norwegian krone, Australian dollar, and New Zealand dollar. The euro also outperformed sterling, with GBP/EUR slipping to €1.18, its lowest level since August 2024. Nevertheless, the currency pair remains in the upper third of its two-year trading range and two cents above its five-year average.

The positive reaction to the tariff delay proved short-lived, as Trump’s subsequent announcement of potential tariffs on Mexico and Canada by the end of the month unsettled markets. Conflicting signals caused currency markets to fluctuate wildly, with GBP/USD retreating below $1.23 this morning. With so many unknowns, it is difficult to call an end to the recent dollar rally, and volatility appears to be the only certainty over the coming weeks and months.

In addition to these external drivers, domestic UK data has come under scrutiny this week. This morning’s UK labour market report revealed that average weekly earnings for November were lower than expected at 5.6%, compared to forecasts of 5.7% and the previous reading of 5.2%. However, the figure excluding bonuses was slightly better than expected, at 5.6%. This data follows recent reports that have raised concerns about economic stagnation, with inflation easing in line with the Bank of England’s (BoE) estimates, GDP growth stalling, and retail sales disappointing.

Traders are anticipating at least two quarter-point BoE rate cuts this year, but given the recent data, this outlook may be overly conservative. Policymaker Alan Taylor recently suggested that the Bank could consider cuts of up to 125-150 basis points if downside risks materialise. This poses a significant headwind for the pound, which could see its appeal further eroded, leaving the $1.20 level as a key downside target for FX traders in 2025.

GBP remains under pressure against both the Euro and the US Dollar as it navigates a challenging week. Against the Euro, Sterling has entered a technical downtrend, with the exchange rate currently at 1.1850 after three consecutive weeks of losses. A break below the 200-day exponential moving average (EMA) last week signals the potential for a sustained decline, as this technical level now acts as resistance. Tuesday’s UK labour market report is a critical event, with rising unemployment and wage data likely to shape market sentiment. Should the data reveal a weaker-than-expected labour market, expectations for further interest rate cuts from the Bank of England may deepen, exerting additional downward pressure on the Pound.

Similarly, GBP/USD remains vulnerable, consolidating around 1.22 but retaining a negative technical outlook. Momentum indicators suggest further losses are likely, with downside targets of 1.21 and potentially 1.1850. The Dollar’s movements will also hinge on US political developments this week, with markets closely watching President Trump’s inaugural policy announcements. The interplay of UK-specific economic challenges and global risk sentiment makes for a volatile environment for Sterling traders.

This week marks the inauguration of Donald Trump as the President of the United States, an event that is set to dominate global market sentiment. Traders are particularly focused on Trump’s initial policy pronouncements, especially on tariffs, taxes, and immigration. A blanket tariff on imports could strengthen the Dollar, as it would likely drive inflation higher and prompt the Federal Reserve to maintain elevated interest rates. However, a more measured approach to trade policies could weaken the Dollar, providing some relief for the Pound and Euro.

Markets remain cautious, with global stocks consolidating ahead of concrete policy announcements. The uncertainty surrounding Trump’s economic agenda adds another layer of complexity for foreign exchange markets, making this a pivotal week for the US Dollar and broader global markets.