Credit Concerns Pressure the US Dollar
The US dollar steadied last week, buoyed by progress in trade negotiations and a reduction in tariff rates, which temporarily allayed fears of economic disruption. However, sentiment swiftly soured following Moody’s decision to downgrade the United States’ credit rating, citing mounting concerns over national debt. The agency cut the US rating from Aaa to Aa1, a move that reignited worries over fiscal sustainability.
While the recent de-escalation in US-China tariffs had supported a risk-on tone and lifted the dollar index for a fourth consecutive week—up 3% from recent three-year lows—underlying structural issues persist. Former President Trump’s musings about reinstating country-specific tariffs have further heightened policy uncertainty, clouding the outlook for the dollar. Moody’s downgrade underscores long-term vulnerabilities, particularly regarding debt sustainability, which could diminish the dollar’s traditional role as a safe haven. Market reactions were swift: US equity futures fell over 1%, while yields on long-dated Treasury bonds approached the 5% mark, reflecting rising anxiety on Wall Street over the US bond market.
Meanwhile, last week’s US economic data painted a mixed picture. Inflation remained subdued, largely due to weaker service-sector spending, although tariff-induced price pressures were evident in goods. Retail sales figures fell short of expectations, indicating continued consumer sensitivity to price increases. Industrial production also contracted, impacted by tariff effects, though supply chain bottlenecks may ease in light of the current trade truce. This week, market focus will turn to jobless claims and flash PMIs. However, the dominant narrative will likely be the market’s response to the US credit downgrade, as debt concerns increasingly drive volatility across asset classes.
Euro Outlook Tied to Dollar Performance
The foreign exchange landscape remains fluid. The recent stabilisation in the US dollar—driven by improved trade sentiment—pushed EUR/USD down to $1.12, while risk-on conditions weighed on traditional safe-haven currencies such as the Japanese yen and Swiss franc. However, following Moody’s downgrade of the US credit rating, the “sell America” narrative has resurfaced, potentially creating room for the euro and other liquid alternatives to benefit.
The euro outperformed other major currencies following “Liberation Day”, as the single currency found a new footing amid resilient economic data. German fiscal support has buoyed the manufacturing sector, while expectations of a deeper ECB rate-cutting cycle may provide marginal stimulus. Nevertheless, the outlook for further euro strength hinges on renewed weakness in the US dollar, as recent price movements have increasingly diverged from economic fundamentals. For a sustained uptrend, EUR/USD would need to recapture the 21-day moving average, currently at $1.1294. The 50-day moving average at $1.1115 remains a critical support level to monitor.
Looking ahead, Thursday’s Flash PMI releases will be pivotal. Markets are anticipating a rebound in the services sector after last month’s unexpected decline—results that could set the tone for the euro’s next move.
UK-EU Summit May Steer Sterling’s Course
Sterling has found support from a series of stronger-than-expected UK data releases, but attention now turns to the first UK-EU summit since Brexit. The government is seeking to recalibrate trade relations with its largest economic partner. GBP/USD has reclaimed the $1.33 level, helped by dollar softness, while GBP/EUR has slipped below €1.19 amid broader risk aversion.
The UK economy showed surprising resilience in Q1, but this momentum may not last. March’s growth was driven by investment and net exports, while both private and public consumption remained subdued. Labour market indicators suggest some loosening, with unemployment rising to 4.5%, job vacancies falling to 761,000, and wage growth plateauing at 5.6% year-on-year. These dynamics point to easing inflationary pressure, reinforcing expectations of a 25 basis point rate cut at the Bank of England’s June meeting.
Nonetheless, inflation could still pose challenges in the short term. April’s CPI figures are forecast to show an acceleration, with headline inflation expected at 3.3% year-on-year, core CPI at 3.6%, and services inflation at 4.9%. Investors will also keep an eye on preliminary PMI data, which may shed light on the broader impact of Trump-era trade policies on the UK economy.
However, the UK-EU summit could prove to be the most decisive driver for sterling. A positive outcome—particularly progress on trade—could support further gains. While a new defence pact is likely, contentious issues such as fishing rights and youth mobility remain unresolved. Officials expect three key outcomes: a security agreement, a joint declaration on global challenges, and a framework for ongoing negotiations.
