Dollar stronger, but key level remains elusive
Foreign exchange markets appear considerably more sensitive to escalating tariff risks than equity investors, who seem relatively complacent about the threats issued by President Trump. While the S&P 500 has remained range-bound since mid-November, it is still up by 6% since the US election, driven by an initial post-election rally. Meanwhile, European equities have slightly outperformed, rising nearly 8% over the same period.
This resilience in global stock markets is particularly notable, given the intensifying trade rhetoric and the significant reduction in expectations for Federal Reserve easing over recent months. However, key upcoming events—Wednesday’s inflation report, Federal Reserve Chair Jerome Powell’s congressional testimony on Tuesday, and further trade developments—could provide the momentum needed for equities to break out of their recent consolidation. The US dollar has strengthened for a third consecutive session, but gains remain limited, with the 3% trading range since mid-December still intact.
As we have previously argued, further upside for the dollar depends on sustained trade escalation and the actual implementation of tariffs. With the Federal Reserve pause fully priced in, the dollar now requires either a stronger US macroeconomic backdrop or deteriorating risk sentiment to make meaningful gains. At present, the high noise-to-signal ratio makes shorting the Greenback a difficult case to justify.
Struggling to hold above $1.0350
EUR/USD extended its losing streak to a third consecutive session, weighed down by dollar strength and ongoing trade concerns. However, the downside has remained limited as European equities continue their impressive performance, with the STOXX 600 closing at a fresh record high, reflecting investor confidence in the region’s economic resilience. Stronger bond yields have also provided some support, as markets reassess the European Central Bank’s (ECB) policy path amid shifting inflation dynamics.
The latest Sentix investor sentiment index showed a marked improvement in eurozone morale, rising to its highest level since July, suggesting that optimism is gradually returning to the region despite persistent economic headwinds. ECB President Christine Lagarde maintained the central bank’s outlook, reiterating that inflation remains on track to return to the 2% target this year. However, she cautioned that rising trade tensions, particularly those stemming from the United States, could pose risks to the outlook, making the ECB’s policy path more uncertain in the months ahead.
Meanwhile, German Chancellor Olaf Scholz issued a stark warning, stating that the European Union is closely monitoring the situation and will not hesitate to retaliate if the US proceeds with tariffs on EU exports. His comments underscored growing concerns that transatlantic trade relations could deteriorate further, injecting another layer of uncertainty into the euro’s outlook. While the currency has managed to hold above key technical levels for now, escalating trade risks and diverging central bank policies could keep EUR/USD under pressure in the near term.
Will the pound outperform the euro again this year?
GBP/EUR is over 1% lower year-to-date but has recently rebounded from five-month lows, thanks to a slightly more optimistic UK domestic backdrop. More significantly, tariff risks are perceived as more damaging to the Eurozone economy than to the UK. The currency pair is encountering resistance around its 50-day moving average at €1.20 but remains above its 200-day moving average, which is trending higher—a sign of sustained upward momentum.
The currency pair continues to avoid substantial daily fluctuations. In fact, GBP/EUR has not recorded a daily rise or fall of 1% or more for over 500 trading days. Though lacking volatility, GBP/EUR experienced a healthy uptrend in 2024, finishing the year nearly 5% higher and recording its highest year-end close since 2016. Two key contributors to this uptrend have been heightened European political risks and elevated UK-German short-term yield spreads, although both have recently stabilised at lower levels. These macroeconomic drivers suggest that GBP/EUR should be trading closer to €1.18-€1.19. Thus, we believe sterling is benefiting from its lower sensitivity to tariff risks compared to the euro. Should tariff threats against the EU materialise, we would not rule out GBP/EUR extending above €1.21—a level it has only surpassed for 1% of the time since Britain voted to leave the EU in 2016.
From a macroeconomic perspective, the Eurozone economy stagnated at the end of 2024, and recent high-frequency indicators suggest that economic activity is likely to remain subdued in the near term. In the UK, economic activity has also weakened, although recent survey data points to a moderate revival. This week’s UK real GDP data is expected to show no economic growth in the fourth quarter of 2024.
In terms of monetary policy, markets are pricing in 66 basis points of Bank of England easing by year-end, compared to 90 basis points for the ECB. The two primary risks to further GBP/EUR upside are increased expectations of BoE rate cuts and a softening of the tariff narrative. The former is already materialising to some extent, with the BoE’s Catherine Mann—previously considered one of the committee’s more hawkish voices—adopting a more cautious tone and expressing concerns about slowing consumption and the labour market.