Inflation Data Overshadowed by Tariff Threat

There was a brief respite in risk sentiment yesterday following some positive news on US inflation. However, the rally in stocks and bonds soon faded as the details of the consumer price inflation data were less encouraging, while fears of a global trade war intensified. The US dollar index ended its seven-day decline but remains close to pre-election levels. Meanwhile, today’s US producer price inflation data could complicate the disinflation narrative, potentially making the Federal Reserve’s (Fed) task more challenging.

Canada and the EU are responding to the sweeping US tariffs on steel and aluminium, signalling an escalation in the global trade war. The US dollar’s 3.7% decline so far this month, along with falls in US equities and their underperformance relative to other markets, marks a significant shift in investor sentiment regarding the economic outlook for both the US and Europe. However, a surprisingly subdued set of February US consumer price inflation figures month-on-month pulled the annual headline inflation rate down to 2.8% from 3%, while core inflation dipped to 3.1% from 3.3%. This temporarily halted the stock sell-off that had pushed the S&P 500 towards a correction. Nonetheless, the underlying details were less reassuring, with a sharp 4% month-on-month decline in airfares (a highly volatile component) largely responsible for the softer inflation reading. Moreover, there is growing anecdotal evidence of firms pre-emptively raising prices in anticipation of potential tariffs, as indicated by this week’s NFIB survey, which reported a 10-point increase in the proportion of companies raising prices. The risk here is that core inflation could reverse course and begin climbing again in the coming months.

Concerns over tariffs are already prompting businesses to push prices higher, increasing the likelihood of stronger inflation readings over the summer. This would further complicate the Fed’s policy decisions amid rising recession fears. In addition, key components from the producer price index, due today, which feed into the Fed’s preferred inflation measure, are expected to have accelerated since January. This could make it more difficult for the Fed to implement rate cuts despite slowing US economic activity. As a result, the outlook for equities and broader risk appetite remains bleak.

Will Trump Halt the Euro’s Rally?

The euro’s recent rally lost some momentum yesterday, slipping below the $1.09 mark. While broader risk sentiment improved after softer US inflation data, European markets faced renewed trade tensions and political uncertainty. President Trump has made it clear that he intends to retaliate against the EU’s countermeasures in response to his 25% tariffs on steel and aluminium. This tit-for-tat exchange will further heighten tensions between the two regions and could cap gains for the euro in the near term.

Meanwhile, German bond markets continue to send strong signals. The 10-year Bund yield surged past 2.9%, its highest level in nearly 13 years, as negotiations over expanded government borrowing intensified. The Greens remain hesitant to fully support the fiscal expansion proposed by the CDU/CSU-led coalition, though alternative proposals suggest a compromise may be within reach. If secured, this could pave the way for a significant increase in Germany’s defence and infrastructure spending—an economic shift that is already beginning to reshape investor sentiment towards the Eurozone.

For now, EUR/USD remains supported by the broader move away from the dollar, but trade risks are becoming harder to ignore. If Trump escalates his response, it could weigh on European equities and the euro in the short term. However, should Germany’s fiscal deal come to fruition, it may provide further support for European assets, especially as concerns over US economic growth mount. Investors will be watching closely for new developments on both fronts in the coming days.

Sterling Nears $1.30

Sterling climbed to a fresh three-month peak of $1.2988 on Wednesday, coming within a whisker of the key $1.30 level, a threshold it has been below for 60% of the past five years. GBP/USD is up 3% so far this month, and nearly two cents above its five-year average of $1.28, though it remains in overbought territory according to the 14-day relative strength index. GBP/EUR also snapped a run of six consecutive daily losses as focus turned to EU-US trade war risks following the EU’s retaliation against US tariffs.

While downside risks for the euro and the Eurozone economy have eased amid hopes of significant fiscal reforms, the tariff issue remains a major short-term headwind for the common currency, potentially limiting the euro’s gains against sterling. We are keeping a close eye on the 50-week moving average, currently at €1.1888. Should GBP/EUR close the week below this level, a slide towards €1.1740 seems plausible in the coming month. Otherwise, the pair may remain in a tight range, given real rate differentials suggest €1.19 is a fair valuation. However, there appears to be greater potential for sterling to hold firm against the dollar, as currency traders assess the likely trajectory of interest rates over the next six months. Both the Fed and the Bank of England (BoE) are set to meet next week, and while neither central bank is expected to cut rates, markets are currently pricing in around three cuts by the Fed later this year, compared with just two expected from the BoE.

Indeed, with UK inflation rebounding and inflation breakeven rates suggesting that retail price increases over the next two years are likely to hover around 4%, the BoE may choose to delay its next rate reduction. This expectation has already pushed UK nominal yields higher relative to those in the US, providing further support for GBP/USD. However, as mentioned earlier, sterling remains in overbought territory, making it vulnerable to a short-term pullback as traders take profits.

USD

The US dollar lost ground against most major currencies yesterday, even as global markets experienced another bout of risk aversion. Typically, rising trade tensions would drive demand for the dollar as a safe-haven asset. However, investors are shifting their focus beyond short-term fluctuations to the broader economic impact of these tariffs. Market trends suggest that mounting worries over slower US economic growth and declining corporate profitability are starting to outweigh the dollar’s immediate defensive appeal. The Greenback has now fallen for seven consecutive days, down 6.5% from its 2025 peak.

President Trump’s latest tariff hike has added to financial market volatility. Just days after broadening import duties on Canada and Mexico, he announced that steel and aluminum tariffs on Canada would double to 50%, citing Ontario’s recent increase in electricity export taxes. This decision sent ripples through equity markets, with the S&P 500 extending its three-week slide to nearly 10%, while the VIX, Wall Street’s "fear gauge," surged to its highest level since last August. The Canadian dollar also dropped to a weekly low, underscoring the outsized impact of trade disputes on North and Central American currencies.  

Beyond tariffs, US economic data offered a mixed outlook. The NFIB Small Business Optimism Index fell to 100.7—its lowest reading since October 2024—as business owners faced near-record levels of uncertainty. Concerns over inflation and labour shortages are mounting, with confidence in future economic conditions taking a significant hit. However, the JOLTS report revealed an increase in job openings to 7.74 million, signalling sustained labour demand in key industries like retail, finance, and healthcare.  

Looking ahead, markets will closely watch US inflation data, central bank signals, and geopolitical developments. The dollar’s recent slump could continue if trade tensions further erode economic sentiment and corporate confidence, as investors weigh short-term market reactions against broader economic trends.

EUR

The euro continues to climb against the US dollar, surpassing the $1.09 level for the first time since Donald Trump’s election. This month alone, the currency has surged over 5.5% as investors pivot away from the US, where fears of a looming recession and uncertainty surrounding trade policy are dampening market sentiment.  

Fuelling the euro’s latest gains are developments in Germany, where talks of a historic fiscal expansion are picking up steam. Franziska Brantner, co-leader of the Greens, has signalled openness to negotiations on increased government borrowing to support defence spending and economic stimulus. While details remain uncertain, markets have reacted positively to the potential for enhanced fiscal support. Paired with expected rate cuts from the European Central Bank (ECB), this combination of monetary and fiscal stimulus is a rare occurrence for the eurozone.  

The shifting political landscape in Europe is also reinforcing the euro’s strength. Hopes are mounting that Germany’s potential policy shift could lead to a significant increase in borrowing and investment over the next decade. However, political hurdles remain, with the Greens resisting broader debt rule reforms and a proposed €500 billion infrastructure fund. Investors will be watching closely in the coming days, as a finalized fiscal agreement could push the euro even higher.  

Meanwhile, growing economic concerns in the US, persistent trade uncertainties, and diverging policy paths between the Federal Reserve and the ECB are weighing on the dollar. With euro bulls firmly in control, traders are focused on any signs of a breakthrough in German fiscal negotiations and further indications of economic slowdown in the US.

GBP

The recent weakness of the US dollar, driven in large part by diminishing expectations of American economic exceptionalism, has coincided with a boost for the pound, likely fuelled by Europe’s fiscal revaluation. However, it is the euro that has reaped the greatest benefits from Germany’s ground-breaking stimulus plan, which includes a debt brake reform to enable increased spending on defence and infrastructure. Following a major shift in sentiment towards the euro last week, EUR/USD has surged more than 5% this month, greatly outpacing GBP/USD’s modest rise of less than 3%.

Over the past two years, sterling has benefitted from a notable yield advantage compared to many other currencies, supporting GBP/USD’s stronger performance against EUR/USD. This trend has also helped push GBP/EUR to two-year highs in recent months. However, this dynamic seems to be changing. With Europe’s economic outlook improving and German bond yields climbing, the euro looks set for a period of sustained outperformance against major rivals, including the pound.

GBP/EUR has already dropped 2.2% this month, falling below its 50-week moving average for the first time in a year. This suggests further downside potential, with a possible move towards €1.17. While the close correlation between EUR/USD and GBP/USD is likely to remain, the euro seems to have more room to climb against the dollar than sterling does.

Looking ahead, on Friday the Office for National Statistics (ONS) is set to publish the UK's Gross Domestic Product (GDP) figures for the fourth quarter of 2024, offering a clearer picture of the nation's economic performance during that time.

Projections for the UK's economic growth remain cautious. The British Chambers of Commerce (BCC) has downgraded its 2025 GDP growth forecast to 0.9%, down from a previous estimate of 1.3%. This revision reflects concerns over rising business costs, including higher payroll taxes and employment expenses, which are expected to weigh on investment and hiring. Similarly, the Bank of England has cut its 2025 growth forecast from 1.5% to 0.75%, citing ongoing economic challenges and uncertainty. 

Although the forthcoming ONS report will provide insight into the UK's economic activity in late 2024, recent forecasts suggest a more subdued outlook for growth in 2025.

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.

The pound’s mixed fortunes

Sterling has been caught in the middle, weakening against the euro but strengthening against the US dollar. The latter move was driven by fears over US economic growth and increased expectations of Federal Reserve rate cuts, which improved UK-US interest rate differentials in the pound’s favour. GBP/USD surged 2.7% last week, breaking through key resistance levels and opening the door to a test of the $1.30 threshold in the near term. However, the daily chart suggests the pair is overbought, hinting at either a correction lower or a period of consolidation. From a valuation perspective, GBP/USD remains 4% below its 10-year average of $1.35.

Against the euro, however, the pound endured its worst week in two years, falling 1.6% before stabilising around its 50-week moving average—a key support level for over a year. The fiscal divergence between the UK and the Eurozone is tilting sentiment in favour of the euro, particularly as Europe’s substantial spending plans fuel growth expectations. Should GBP/EUR struggle to reclaim its 200-day moving average at €1.1929, further downside could be in store. However, a more stable UK fiscal outlook should help limit sterling’s losses, while near-term monetary policy and the pound’s yield advantage remain supportive.

In focus this week is the UK’s latest GDP data. The British economy has been on fragile footing since mid-2024, and January’s figures are expected to confirm a slowdown in growth from 0.4% to 0.1% month-on-month. However, the three-month average is forecast to improve from 0.0% to 0.2%. Unless the data significantly deviates from expectations, it is unlikely to influence Bank of England policy projections.

No "Trump put" to hope for?

The US dollar suffered its largest weekly decline since 2022, driven by a combination of economic uncertainty, weakening data, and renewed optimism in European markets following Germany’s historic debt announcement. Investors were left uneasy as concerns over trade, fiscal policy, and monetary direction continued to weigh on sentiment.

On Friday, US labour market data pointed to a slowdown, with nonfarm payrolls rising by 151,000—falling short of the 160,000 consensus estimate. While the miss was not drastic, it added to fears of an economic deceleration. At the same time, President Trump’s decision to delay tariffs on Canada and Mexico failed to reassure markets, which remained focused on long-term stability rather than short-term adjustments.

Investor confidence in Trump’s second term has also started to wane, as expectations of a repeat economic boom appear increasingly unrealistic. Both the President and Treasury Secretary Bessent have acknowledged the need for structural reforms, warning that market turbulence may accompany government policy changes. With government spending and employment levels deemed excessive, Bessent stressed that a reduction in both is necessary. As a result, investors are beginning to accept that there may be no “Trump put” after all.

US equities ended the week lower, reflecting these concerns, though Federal Reserve Chair Jerome Powell provided some temporary relief on Friday. Powell reassured markets that the economy remained on solid ground and that he was not overly alarmed by current conditions. However, his remarks failed to arrest the dollar’s slide, which continued into the weekend. With growing doubts over Trump’s economic agenda, history suggests that his approval ratings could also be at risk of a decline.

Betting on Europe again

The euro gained significant ground last week, benefiting from broad dollar weakness, a shift in investor sentiment, and renewed fiscal optimism in the Eurozone. Germany’s historic debt issuance announcement strengthened expectations of robust economic growth, while the European Central Bank’s (ECB) quarter-point rate cut was counterbalanced by a more cautious policy outlook.

On Saturday, ECB Executive Board member Isabel Schnabel warned that Eurozone inflation is more likely to remain above the 2% target for an extended period than to sustainably decline below it. Her remarks signalled a growing resistance within the ECB to further rate cuts in the near term. As policymakers prepare for a crucial decision in April, divisions are emerging over the extent of further monetary easing. Meanwhile, Europe’s economic landscape continues to evolve, with governments set to deploy hundreds of billions of euros in defence and infrastructure investment, particularly in Germany.

The euro surged by 4.4% against the dollar last week, marking its strongest advance since 2009—the year Germany introduced its debt brake. However, resistance emerged around the $1.0850 level as traders reassessed the implications of a hawkish ECB amid improving economic conditions. Looking ahead, market participants will closely watch Eurozone inflation data and ECB communications for further policy signals. With the region’s cyclical recovery gaining traction and inflation risks still high, expectations of additional ECB easing are becoming increasingly uncertain.

Carney to the rescue!

Former Bank of England Governor Mark Carney is set to become Canada’s next prime minister—at least for now. He will need all his experience in managing economic crises, as the country braces for an escalating trade war with its largest trading partner, the United States.

Carney made history in 2013 as the first non-British governor of the Bank of England, having previously steered Canada through the Great Recession as head of the Bank of Canada. His reputation for crisis management saw him recruited to Britain’s top banking role, where he played a key part in navigating post-financial crisis recovery and the Brexit fallout.

Unlike most prime ministerial hopefuls, Carney has never held elected office. Yet, he convincingly won the leadership contest to replace outgoing Prime Minister Justin Trudeau. Now, he faces one of Canada’s biggest economic challenges—a deepening rift with the US under President Trump’s aggressive trade policies.

However, remaining in power will be a challenge of its own. Canada’s next federal election is scheduled for October, but speculation is growing that it could be called as early as this month. Carney’s ability to transition from technocrat to politician will be tested as he seeks to steer Canada through economic turbulence while securing his position as prime minister.