Dollar strengthens despite economic headwinds and trade concerns

The US dollar extended its winning streak for a third consecutive day, buoyed by robust end-of-month buying activity, strong corporate earnings, and growing hopes that trade frictions may be easing. Investor sentiment has been lifted by President Trump’s recent remarks suggesting forthcoming trade agreements with India, Japan, and South Korea, along with continued optimism about reaching a deal with China. This shift in tone has lent support to the dollar, despite it recording its weakest monthly performance since late 2022—largely due to the growing momentum behind global moves to reduce reliance on the greenback.

However, the broader outlook for the US currency remains clouded by fresh economic data that point to increasing fragility. Figures released yesterday reveal that the US economy shrank by 0.3% in the first quarter of 2025—its first contraction since early 2022 and a marked reversal from the 2.4% growth seen in the previous quarter. A major contributor to the downturn was a dramatic 41.3% spike in imports, as companies rushed to secure goods ahead of expected tariff increases. This surge widened the trade deficit and led to a record 5 percentage point drag on GDP from net exports. Government expenditure also faltered, reducing growth by 0.25%—its first negative contribution in three years—while private sector spending fell significantly under the weight of growing uncertainty.

The rush to front-load imports, reminiscent of similar behaviour observed in previous tariff cycles, has further complicated the economic picture. These distortions have skewed headline indicators, exaggerating short-term volatility and making it harder to gauge the underlying health of the economy. While the downturn was broadly in line with expectations, the data underline persistent concerns about the direction of US economic growth.

The pace of consumer spending growth in the US slowed to just 1.8% in the first quarter of 2025—its weakest rate since the second quarter of 2023—highlighting growing pressure on household activity. This deceleration points to the likelihood of continued economic softness in the second quarter. The recent introduction of new tariffs on 2 April has yet to filter through into the economic data, but early signs suggest that consumers are already feeling the strain. The combination of trade policy uncertainty and a broader slowdown appears to be weighing increasingly heavily on domestic demand.

In addition, fresh inflation figures have given policymakers little reason for reassurance. The Federal Reserve’s preferred gauge of inflation—the Personal Consumption Expenditures (PCE) price index—rose by 2.3% year-on-year in March 2025. While this marks the slowest annual increase in five months, it still exceeded market expectations of a 2.2% rise. Compounding the picture, February’s reading was revised upwards to 2.7%. Although the pace of inflation is showing signs of cooling, the higher-than-expected print complicates the Federal Reserve’s policy calculus and has reignited concerns about stagflation, as slowing growth coincides with persistent price pressures.

Euro retreats from highs despite record-breaking April performance

April marked a historic milestone for the euro, delivering its strongest performance against the US dollar for that month since the euro’s introduction in 1999. However, gains proved fleeting as EUR/USD slipped below the $1.13 threshold this morning, following renewed optimism from President Trump over potential trade agreements with key international partners.

The revival in market confidence and growing belief that the worst of global trade tensions may have passed has put pressure on the euro in recent days. Interestingly, the single currency had been an unexpected beneficiary during earlier phases of trade uncertainty, favoured by investors as a relatively inexpensive and liquid alternative. Support has also come from the eurozone’s current account surplus and a notable fiscal boost from Germany’s landmark public spending initiatives. Although the euro has retreated from three-year highs, diverging economic signals from either side of the Atlantic continue to shape sentiment and may offer further scope for appreciation in the months ahead.

While the US economy unexpectedly contracted in the first quarter, shrinking by 0.3%, the eurozone expanded by 0.4%, fuelled by robust domestic consumption. Germany’s GDP grew by 0.2% as anticipated, while France recorded more modest growth of 0.1%.

Inflation dynamics within the euro area remain mixed. German headline inflation softened to 2.1% in April, though underlying price pressures ticked higher. In contrast, France’s annual inflation rate held steady at 0.8%. Financial markets are increasingly confident that the European Central Bank will ease policy further, with expectations currently pointing to a rate cut in June and a total of 67 basis points of reductions by the end of the year.

GBP/USD hovering near 38-Month high as market momentum shifts

The pound is trading just below $1.34 this morning, holding close to its highest level in over three years after briefly touching that mark on Tuesday. This recent strength has been fuelled by a broadly weaker US dollar and calmer market conditions. With a 3.8% gain so far in April, sterling is on track for its best monthly performance since November 2023.

However, against the euro, the picture is less favourable. Sterling is heading for a second consecutive monthly decline of around 1.5%, the sharpest two-month drop since the latter part of Q3 in 2022.

The UK’s limited exposure to current US trade restrictions—temporarily suspended until July—has helped mitigate some external risks. In fact, the US is expected to run a $12 billion goods surplus with the UK this year, standing in contrast to trade deficits with China and the EU. Still, Britain’s heavy dependence on global trade and investor sentiment leaves it exposed. Recent flash PMI data showed UK business activity has fallen to its lowest level in three years.

The Bank of England’s cautious stance on interest rate cuts—markets are pricing in 85 basis points of easing this year—has lent some support to the pound. Yet, correlations between FX and rates markets have become increasingly unreliable.

Technical signals such as the relative strength index suggest the pound's rally against the dollar may be losing traction. Even so, rising concerns over the health of the US economy—and the waning dominance of the “American exceptionalism” narrative—could give GBP/USD further upside potential, especially if upcoming US data underwhelms.

Dollar steadies for now, but economic headwinds strengthen

The US dollar has recently levelled off, following President Trump’s partial retreat from aggressive policy stances on the Federal Reserve and trade. While this has helped calm markets temporarily, the broader pressures on the dollar remain firmly in place. Rather than fears about the dollar’s role as a global reserve currency, the real concern lies in the potential for a sharp US economic slowdown, driven by trade disruptions and increased uncertainty.

Recent data points suggest mounting risks. Investors are closely eyeing the first-quarter GDP figures due today, against a backdrop of weakening indicators. Job openings have disappointed, though a reduction in layoffs offers a modicum of reassurance. However, consumer confidence has taken a notable downturn, reaching its weakest level since May 2020. The expectations index has plunged to levels last seen in 2011, reflecting widespread anxiety largely triggered by the newly introduced global tariffs, which rattled markets when announced and continue to cast a shadow over the economic outlook.

The labour differential—measuring the gap between jobs being plentiful versus hard to get—has also slipped to a six-month low. Still, this isn’t ringing alarm bells yet. Markets have shown limited reaction so far, though that may change quickly if job losses begin to accelerate. All eyes are now on Friday’s jobs report, which could prove pivotal.

Meanwhile, the trade picture is showing signs of strain. March saw the US goods deficit hit a record $162 billion, well above forecasts, as import volumes surged. This rise reflects a pre-tariff buying spree by businesses and consumers attempting to beat the 2 April tariff deadline—highlighting how policy signals are already having tangible effects on trade dynamics and economic data.

Euro climbs as broader shifts undermine Dollar

The euro is on course for its best monthly rise since late 2022, though some near-term volatility could emerge—particularly if month-end investment flows rotate back into the US dollar, following weaker US equity performance and dollar softness throughout April.

The drivers behind the euro’s advance extend well beyond interest rate dynamics. Global markets are now navigating a far more intricate backdrop, shaped by political uncertainty, policy divergence, and a slow but steady shift away from the US dollar in global trade and finance.

While there has been a cooling in short-term euro enthusiasm, positioning in currency options suggests this is temporary. Traders are signalling renewed appetite for euro strength, as seen in the widening spread between one-week and one-month risk reversals. Longer-dated contracts are also leaning more bullishly, with one-year risk reversals nearing their firmest levels since September 2020.

The single currency’s strength is not solely down to optimism around the eurozone. Germany’s recent fiscal stimulus announcements gave the initial lift, but the real engine behind the euro’s rise has been sustained dollar weakness. As investors reassess global currency trends, the idea of EUR/USD reaching $1.20 this year is gaining increasing support.

Looking ahead

For the remainder of the week, FX markets are facing a mix of event risks and underlying structural factors. Key economic data, particularly Friday’s Non-Farm Payrolls report, will likely influence expectations around US interest rates and the US dollar’s trajectory. In addition, releases such as the ISM Services PMI and Initial Jobless Claims will provide further insight into the US labour market and inflationary trends.

Month-end portfolio rebalancing flows could lead to temporary volatility, especially if equity weakness or bond buying persists, potentially affecting the USD and other currencies.

With GBP/USD near a 38-month high and EUR/USD continuing its upward movement, markets remain sensitive to technical resistance levels and shifts in investor positioning, which could result in profit-taking and short-term reversals.

In the background, ongoing tariff wars and trade policy uncertainties will continue to affect market sentiment. These tensions, particularly between the US and key trading partners, may keep volatility elevated as businesses and investors adjust to the shifting landscape. Additionally, geopolitical risks, such as instability in the Middle East and Ukraine, may drive demand for safe-haven currencies like the USD, JPY, and CHF.

Sterling stumbles and trade tensions cloud global outlook

The US dollar continues to languish near its weakest level in three years against a basket of major currencies. While foreign exchange volatility has calmed somewhat from recent historic peaks, attention now shifts to the incoming stream of US economic data as traders seek clues on the tangible effects of ongoing trade friction.

Although the recent turbulence over tariffs has receded somewhat, a full-scale breakdown in trade relations has thus far been sidestepped. Nevertheless, global tariff barriers remain sharply elevated compared to the period before so-called 'Liberation Day.' Currently enforced measures include a blanket 10% levy alongside targeted duties on strategic sectors such as steel, aluminium, the automotive industry, and potentially pharmaceuticals. These tariffs, even with a temporary 90-day reprieve, risk dragging global commerce back to protectionist levels last witnessed decades ago.

Equity markets, having enjoyed a brief resurgence, now appear increasingly exposed. Early hopes for a substantial thaw in tensions between Washington and Beijing are beginning to wane. What little optimism there was—fostered by a short-lived easing of hostilities—could quickly unravel should talks falter or geopolitical strain resurface. In such a case, investor appetite for risk may well dry up, placing downward pressure on global markets.

Looking ahead, market participants will be closely scrutinising a raft of high-impact US data releases. Notably, the first estimate of Q1 GDP growth and April’s non-farm payrolls report are on the agenda this week. Consensus for GDP growth stands at an annualised 0.4% on a quarterly basis, though estimates vary considerably, shaped by front-loaded import activity and buoyant corporate investment in early 2025.

Euro finds its footing as market forces tilt the scales

In the short term, EUR/USD is likely to hover between $1.13 and $1.14, with a slip toward $1.1250 possible if upcoming US economic figures come in stronger than forecast. Conversely, a climb towards $1.15 could materialise if this week’s employment data hints that trade-related uncertainty is already taking a toll on the American labour market. The euro remains roughly 10% stronger against the dollar compared to the start of the year, comfortably above its long-term moving averages. Currency option markets are even positioning for a possible push towards $1.20 before year-end.

While the European Central Bank is anticipated to cut interest rates once again, expectations are mounting that the US Federal Reserve may also ease policy at its June meeting. The possibility of rate reductions on both sides of the Atlantic may, paradoxically, offer the euro some resilience over the coming months.

European financial markets could also receive a lift from renewed diplomatic optimism, with Ukrainian President Zelenskiy voicing hope for a lasting peace following conversations with President Trump.

Additionally, shifting dynamics in global energy demand are tilting in Europe’s favour. Concerns over a potential US recession, slowing growth in China, and fractures within OPEC+ are weighing on oil prices. For energy-importing economies like those in Europe, lower crude costs provide a welcome economic cushion—especially for transport and manufacturing sectors. This evolving landscape could offer the euro yet another layer of support as the year progresses.

Sterling rally stalls as market turns cautious

The pound edged up by roughly 1% on Monday, lifting GBP/USD back above the $1.34 threshold and brushing against levels last seen three years ago. However, the upward drive appears to be losing steam, restrained by a modest bounce in the US dollar and a more restrained tone across global markets.

Sterling is also grappling with increased speculation that the Bank of England will reduce its benchmark interest rate by 25 basis points to 4.25% in May. All eyes are on a forthcoming speech from BoE policymaker Dave Ramsden, set for Tuesday. Should his remarks strike a dovish chord, it may weigh further on the pound's short-term trajectory.

Even so, the pound remains well-supported against most of its major counterparts, with the exception of traditional safe havens like the yen, euro, and Swiss franc. Encouragingly, against the euro, sterling has reclaimed its position above the 21-day moving average—potentially signalling the early stages of a bullish shift.

The GBP/EUR cross is likely to find continued backing as long as global risk appetite holds firm, given the pound’s relatively higher sensitivity to shifts in investor sentiment compared to the euro.

GBP/USD rally falters at key resistance

The GBP/USD pair strengthened over the past week; however, the sharp pullback from the key resistance level of 1.3400 has heightened market attention on the potential for further weakness.

While trade tariff developments faded into the background, market sentiment was instead shaped by renewed tensions between US President Donald Trump and Federal Reserve Chair Jerome Powell. Early in the week, fears that Trump might attempt to remove Powell triggered a decline in the US dollar. However, as these concerns eased, the dollar managed to regain lost ground.

On a technical basis, momentum indicators such as the Relative Strength Index (RSI) are also signalling the possibility of a reversal in the GBP/USD pair.

ECB rate cuts dependent on economic deterioration

Martins Kazaks, a member of the European Central Bank’s Governing Council, has indicated that the ECB should only lower interest rates to an “accommodative” level if the economic outlook worsens materially, according to Bloomberg.

Speaking in Washington over the weekend during the IMF’s spring meetings, Kazaks noted that while US trade policies could slow inflation and potentially lead to a recession, there is still little clarity over future developments. He stressed that cutting rates too much now would unnecessarily limit the ECB’s future policy options.

“The real issue is whether we would need to move significantly below 2.00%, but at the moment we are at 2.25%,” he said. “We will act if necessary, but any further reduction to control inflation would require a clear deterioration in economic conditions.”

EUR/USD has recently retreated from short-term highs. Attention now turns to the 21-day EMA, with the 1.1219 support level proving critical for the next move in the pair.

Looking ahead

The week ahead is set to see inflation data dominate attention across major economies. In Australia, first-quarter CPI figures (due Wednesday) are expected to show a quarterly increase of 0.8% and a year-on-year rise of 2.3%, offering valuable insight into the Reserve Bank of Australia’s future policy direction.

In Europe, preliminary inflation readings from Germany and France (also Wednesday) will shed further light on price pressures within the Eurozone, ahead of Eurozone-wide CPI data scheduled for release on Friday. These reports are likely to influence expectations regarding the European Central Bank’s (ECB) next steps.

Meanwhile, in the United States, Personal Income and Spending data will be published on Thursday alongside the PCE price index—widely viewed as the Federal Reserve’s preferred inflation gauge. These numbers will be closely scrutinised as speculation over the Fed’s next move continues.

Attention will also turn to growth figures. The preliminary estimate for US Q1 GDP, due Wednesday, is expected to show annualised growth of just 0.4%. The Eurozone will release its own first-quarter GDP figures later in the week. These will be accompanied by manufacturing PMI updates from the United States (Thursday) and Europe (Friday), offering further signals on the broader economic landscape.

The Bank of Japan (BoJ) will deliver its policy decision on Thursday, with markets anticipating no change to its benchmark interest rate, which is expected to remain at 0.5%.

Labour market data from the US, out on Friday, will also be closely watched. Nonfarm payrolls are forecast to rise by 123,000 in April, a marked slowdown compared to March’s strong 228,000 reading, while the unemployment rate is expected to hold steady at 4.2%. These figures should offer further clues about the resilience of the US labour market under tighter monetary conditions.

In the United Kingdom, a quieter economic calendar lies ahead, with CBI realised sales on Monday, the BRC shop price index on Tuesday, and loan growth figures due Thursday.