Tariff Uncertainty Lingers as Markets Navigate Policy Shifts

Hopes for trade stability were short-lived as the U.S. granted only a temporary reprieve in its tariff standoff with Mexico and Canada, delaying new levies by a month. While this provided brief relief to markets, the broader uncertainty surrounding U.S. trade policy remains a key risk. Meanwhile, tensions with China have escalated further—after a planned call between Xi and Trump failed to materialize, the U.S. proceeded with a 10% tariff on Chinese imports, prompting Beijing to retaliate with additional levies on 80 products, effective February 10th. All eyes will be on the yuan as Chinese markets reopen after the Lunar New Year break, with traders anticipating a stable or stronger fixing from the People’s Bank of China.

In 2023, China’s exports to the U.S. were valued at around $500 billion, while U.S. exports to China amounted to approximately $124 billion. This trade imbalance has been a key point of tension in U.S.-China economic relations, and the imposition of trade tariffs is likely to escalate the issue. However, given the disparity in exports, China must adopt a measured approach in its response.

The deepening trade rift is adding pressure on the Eurozone, which finds itself caught between the world’s two largest economies. With significant trade links to both, the region faces mounting economic risks.

Despite the uncertainty, the euro found some support as the delay in tariffs for Mexico and Canada spurred buying interest, pushing EUR/USD above $1.0350. While the currency pair is slightly higher on the year, it remains down 3.5% over the past 12 months and 7.3% over the last five months.

On the economic front, today’s stronger-than-expected Eurozone inflation data challenges market expectations of aggressive ECB rate cuts. Inflation accelerated for a fourth straight month, reaching 2.5% in January 2025, while core inflation held firm at 2.7%, exceeding forecasts.

Pound Under Pressure as Growth Concerns Mount and BoE Rate Cuts Loom

The British pound remains on the defensive as weak economic data, persistent inflation worries, and shifting Bank of England (BoE) expectations weigh on market sentiment. While the BoE has maintained a cautious stance, investors are increasingly pricing in rate cuts later this year amid signs of slowing economic growth. Recent data has offered little support for sterling, reinforcing concerns that the UK economy is struggling to gain traction.

Economic indicators continue to highlight softening demand. The latest S&P Global/CIPS UK Services PMI inched up to 51.2 in January from 51.1 in December, slightly exceeding expectations of 50.9. While this suggests modest expansion in the services sector, a drop in new orders for the first time in over a year raises concerns about future momentum.

Despite these headwinds, the pound has regained some ground following the U.S. decision to delay tariffs on Canada and Mexico, which helped ease broader market uncertainty. The UK’s lower exposure to U.S. tariffs, due to its services-heavy export mix, has provided some relief. As a result, GBP/EUR is climbing for a third straight session above €1.20, though GBP/USD remains under pressure, struggling to sustain gains above $1.25.

Tariff Turmoil Fuels Market Volatility

Uncertainty surrounding tariffs is driving sharp fluctuations across asset classes. Over the weekend, the US adopted a tougher stance, triggering a plunge in stocks and cryptocurrencies, a surge in US yields, and a significant rally in the US dollar. However, markets reversed course after news broke that tariffs on Mexico and Canada would be delayed for a month following discussions between leaders on Monday.

The turbulence didn’t stop there—China’s tariff deadline passed, prompting retaliation with levies on US LNG, coal, crude oil, and farm equipment, alongside an antitrust probe into Google. As a result, oil fell by 2%, and the Chinese yuan weakened by 1% against major currencies.

Tariffs remain the dominant market driver, with Trump viewing them as a strategic tool. The key questions now are how much he is willing to negotiate post-implementation and what deals he is prepared to strike. Until more clarity emerges on the duration and scale of these tariffs, volatility is expected to persist—particularly in FX markets. Growth-sensitive and commodity-linked currencies are likely to remain under pressure, while safe-haven demand strengthens the appeal of the Japanese yen and Swiss franc as diversification options beyond the US dollar.

Euro Under Pressure as Trade Risks Mount

The euro’s fortunes took a sharp turn after Trump’s election in November, tumbling from a peak of $1.12 last year to around $1.01. The currency faces mounting headwinds, both political and cyclical. A no-confidence vote in France, expected on Wednesday, adds to the uncertainty, but speculation that the US will restrict trade with the EU is the latest and most pressing threat—one that raises the risk of EUR/USD falling to parity or lower.

Trade tensions have also reinforced the monetary policy divergence narrative, further weighing on the euro. Investors are increasingly betting on aggressive European Central Bank (ECB) rate cuts due to slowing growth, with more than three cuts priced in for 2025. This has sent German bund yields sliding, while expectations for the Federal Reserve have moved in the opposite direction, pushing US Treasury yields higher. As a result, the US-German yield spread is near its widest level in five years, exacerbating EUR/USD weakness.

The key question now is whether markets have fully priced in the trade-risk premium. With EUR/USD only about 2% from where rate differentials suggest fair value lies, the risk remains that a larger premium needs to be factored in, reflecting Trump’s hardline tariff stance.

Unless a reversal in trade policy emerges, EUR/USD could retest its cycle low and move toward the psychologically significant parity level. Market sentiment has turned increasingly bearish, with FX options positioning showing the most pessimistic outlook for the euro in six months, as reflected in one-week risk reversals.

Pound Finds Respite from Tariffs but Risks Remain

Britain appears poised to avoid US tariffs, largely due to its goods trade deficit with the US. While the UK runs a trade surplus in services, these are difficult—if not impossible—to target with tariffs. However, despite this exemption, the pound remains a risk-sensitive currency, and the UK’s heavy exposure to higher interest rates keeps downside risks in focus for GBP/USD. That said, as seen with GBP/EUR’s gap higher on Monday, sterling could outperform its European peers in this escalating tariff environment.

US trade data underscores the rationale behind Britain’s likely exemption. The US runs a goods trade deficit of $209 billion with the EU, $279 billion with China, $152 billion with Mexico, and $68 billion with Canada, but holds a $9.7 billion goods trade surplus with the UK. While this suggests Britain may stay out of the firing line, calling the pound a safe-haven currency remains questionable. The UK is still vulnerable to global trade tensions—especially if a slowdown in the EU, its largest trading partner, weighs on growth. Additionally, the impact of higher interest rates will further strain the Treasury, with rising borrowing costs and limited fiscal flexibility adding to economic pressures.

Sterling could extend gains against the euro toward €1.21–1.22, well above its five-year average of €1.16. However, against the dollar, near-term risks remain tilted lower. If EUR/USD falls to parity, GBP/USD could trend closer to $1.20, given the strong correlation between the two exchange rates.

Markets Brace for Another Pivotal Week Amid Escalating Trade Tensions

This week is shaping up to be another critical one for global markets. Following an eventful stretch that saw the Federal Reserve push back on rate cut expectations and the European Central Bank deliver a widely anticipated cut, the Trump administration has now escalated trade tensions over the weekend with sweeping new tariffs.

The U.S. has imposed fresh levies of 25% on imports from Canada and Mexico, along with a 10% tariff on Chinese goods—without exceptions for consumer products, a departure from Trump’s first presidency. Additionally, the favourable de minimis exemption, which allowed certain low-value imports to bypass scrutiny and tariffs, will be removed.

Trump stated that tariffs on the EU are inevitable. However, he has yet to target the UK directly, likely due to the unique structure of its economy, the dominance of its services sector, and the absence of deeply integrated supply chains with the U.S.

With markets already navigating a fragile macroeconomic landscape, this latest trade dispute injects further uncertainty into the outlook. The newly imposed tariffs now cover nearly half of all U.S. imports, raising the average tariff rate from 3% to 10%. 

Euro Slides as Tariff Risks Mount, Parity in Sight

The euro has tumbled over 1% against the U.S. dollar, slipping into the mid-$1.02 range amid escalating tariff concerns. President Trump reaffirmed that tariffs on the European Union “will definitely happen,” significantly increasing the risk of EUR/USD approaching parity in the near term.

While the EU has pledged to respond decisively to any tariffs, this is unlikely to stop markets from pricing in further policy easing from the European Central Bank (ECB). As a result, German bond yields are expected to decline further, adding pressure on the euro. Although Trump has yet to specify the scope and scale of the tariffs, the uncertainty comes at a particularly fragile time for Europe, with Germany’s national elections looming and France’s new government facing a parliamentary battle over its budget.

With a wave of political risks weighing on the euro, any economic fallout from U.S. tariffs could accelerate its decline, potentially dragging EUR/USD toward its 2022 lows around 0.95 in the months ahead.

BoE Rate Cut Expected, but Market Focus Shifts to Future Policy Path

The Bank of England (BoE) is widely expected to cut interest rates this week, but the key market focus will be on the vote split and policy messaging, which will offer clues on the pace of further easing this year.

December’s meeting signalled a surprisingly dovish shift, with three members voting for consecutive cuts and the majority highlighting concerns over weak output and employment. The UK economy showed signs of stagnation in the fourth quarter, raising fears of a potential technical recession. If the BoE signals a more aggressive easing cycle than markets currently anticipate, it could weigh on the pound through lower yield expectations.

ECB Signals Confidence in Disinflation with Rate Cut, More Reductions Likely

The European Central Bank (ECB) reinforced its confidence in the ongoing disinflation process by unanimously approving a 25 basis point rate cut during its January meeting. While maintaining a meeting-by-meeting approach, concerns over weak economic growth make another rate cut in March highly probable, with further reductions expected in the coming months.

The ECB’s stance is supported by wage growth aligning with projections and survey data indicating a stable inflation outlook. Notably, the bank did not address the recent spike in energy prices or rising inflation expectations, suggesting these factors are not viewed as major obstacles to disinflation. Although GDP stagnated in the fourth quarter, the ECB remains optimistic about recovery, citing higher real incomes, looser financial conditions, and stronger foreign demand. However, risks persist, including potential trade tariffs, higher long-term interest rates, and labour market vulnerabilities.

During the press conference, ECB President Christine Lagarde avoided discussion on the neutral interest rate. However, her past remarks indicating a neutral range of 1.75% to 2.25% suggest that a March rate cut is highly likely, with another possible in April as the ECB shifts away from its restrictive stance. As the policy rate approaches 2%, debates among policymakers are expected to intensify.

Overall, the ECB’s latest meeting signalled a slightly more dovish stance than anticipated, easing concerns of a slowdown in rate cuts. Current projections indicate a 25 basis point reduction at each meeting until July, bringing the deposit rate to 1.75%—in line with the broad consensus on the neutral rate. The EUR/USD remained stable around the $1.04 level, showing little reaction to rate decisions from both the ECB and the Federal Reserve.

Pound Struggles Amid Risk Sentiment and Tariff Concerns

The pound has been highly sensitive to risk sentiment this week, reaching a four-week high against the USD on Monday before reversing course due to a global equity selloff and renewed tariff risks unsettling markets. While GBP/USD broke above a four-month descending trend line, it has struggled to reclaim the $1.25 level, with the 50-day moving average acting as a strong resistance point.

Like the euro, the pound’s recent weakness is largely tied to expectations surrounding the US economy and Federal Reserve policy. Strong US GDP data released yesterday fell short of expectations, slightly weighing on the dollar. The divergence between UK-US rate differentials and GBP/USD since November could partly reflect a tariff risk premium, but it also signals a lack of investor confidence in UK fiscal policy. The Chancellor’s speech this week failed to ease these concerns. However, gilts had already stabilized in recent weeks, and better-than-expected macro indicators—such as PMI and CBI surveys—have provided the pound with some domestic support.

Looking ahead, sterling could face renewed pressure if fiscal consolidation in March and a decline in services inflation in Q2 materialize, as this would likely increase bets on Bank of England (BoE) rate cuts. The BoE is expected to lower rates by 25 basis points next week, with only two additional cuts currently priced in for the year.

Market Uncertainty Rises Ahead of Tariff Deadline

The upcoming February 1st tariff deadline has added to market uncertainty, as investors grapple with the lack of clarity surrounding potential tariff rollouts by the Trump administration. Just two days ago, the White House confirmed plans to impose a 25% levy on Canadian and Mexican goods starting February 1st. However, the absence of concrete details has made it difficult for markets to fully price in the potential impact.

Meanwhile, the US dollar has regained strength following a two-and-a-half-week decline that saw the US Dollar Index drop by 3% at its lowest point. Despite the Federal Reserve’s Wednesday meeting being perceived as slightly more dovish than expected and US GDP figures missing forecasts, the dollar remains dominant in the FX market. Unless there is a significant deterioration in economic momentum, this trend is unlikely to shift—especially in the current politically charged and volatile environment.