Trade tensions test market nerves but resilience persists
No new trade deal has emerged this week. Yesterday, Trump insisted there would be no more extensions past 1 August, which was already another delay in itself, and threatened steep tariffs of 50% on copper and 200% on pharmaceuticals. Despite these dramatic threats, the S&P barely moved and the dollar strengthened, showing markets have grown accustomed to Trump’s brinkmanship.
America’s trade policy has remained controversial, from its questionable tariff calculations to using levies as bargaining chips. The administration’s insistence that the trade deficit is an urgent problem has also been criticised as an oversimplification.
The main concern is that if such sweeping policies are handled poorly, the fallout could be severe. This was evident when the dollar weakened in April after new tariffs were announced. Yet in recent days, the economy has shown resilience, easing fears and supporting the dollar, which has gained about 0.4% this week.
While worries about the outlook persist, familiarity with this combative trade strategy has steadied markets. Technical factors also play a role: the dollar is much more oversold than a few months ago, setting the stage for a possible rebound. Combined with hopes of deals to reduce tariffs, there are reasons to expect a near-term recovery.
Euro rally loses steam as short-term caution grows
The euro’s earlier surge has lost momentum and is likely to stay under pressure throughout the rest of the week. After starting the month with notable strength and even managing a brief climb above the $1.18 level, the rally soon ran out of steam. The EUR/USD pair is currently trading a little more than 0.5% lower since the start of the month, although it still boasts an impressive rise of roughly 13% so far this year.
Market sentiment in the near term has become more wary. One-week and one-month risk reversals have shifted towards euro puts, showing that bearish positions are now outpacing bullish ones. This reflects mounting anxiety about short-term threats to the currency. By contrast, risk reversals with longer maturities continue to display a positive bias, indicating that investors remain broadly hopeful about the euro’s medium-term trajectory.
Whatever the ultimate scale of tariffs imposed, the prevailing view is that the European Union is more exposed to economic harm than the United States. This is largely because of its heavier reliance on exports and comparatively softer economic fundamentals. Such concerns have encouraged a more negative short-term stance, even though positioning further out on the horizon still highlights the persistent vulnerabilities facing the dollar, which in turn underpins a constructive outlook for the euro once the immediate uncertainty recedes.
Nevertheless, the longer-term optimism towards the euro, as seen in options pricing, is fundamentally tied to structural weaknesses in the U.S. economy. As has been argued previously, unless international investors continue to see strong incentives to reduce their exposure to American assets, capital flows into Europe could begin to falter.
Pound under pressure as debt worries intensify
The British Pound has slipped once again as concerns about the country’s finances return. UK bond yields surged and sterling declined after the Office for Budget Responsibility (OBR) released a report warning that Britain’s debt path is becoming unsustainable.
The OBR’s Fiscal Risks and Sustainability update stated that efforts to steady the public finances have achieved only limited success, leaving the UK with some of the highest debt and borrowing costs among developed economies. The publication came days after markets reacted badly to the government’s decision to abandon welfare reforms that would have saved a modest £5 billion a year.
Last week, Rachel Reeves, the top finance official, was visibly upset in Parliament, fuelling speculation over whether she would keep her position. This uncertainty unsettled investors, leading to a decline in the Pound and a spike in gilt yields, which are widely seen as early warning signs of fading confidence in the UK’s fiscal outlook.
The OBR now expects borrowing to exceed 20% of GDP and debt to surpass 270% of GDP by the early 2070s if policies remain unchanged. While rising yields often attract investors seeking better returns, they can also signal growing fear over default and inflation risks.
Pensions spending poses a particular challenge. It currently stands at £138 billion, or 5% of GDP, and could reach nearly 8% by the 2070s. The cost of the triple lock guarantee alone has trebled in forecasts.
These pressures risk sending a clear message to currency markets that Britain’s finances may be on an increasingly shaky footing, putting the Pound at further risk.
