Optimism Over Trump’s Tax Plans

Optimism Over Trump’s Tax Plans

US stocks closed at a five-week low yesterday, while bonds surged, as another disappointing reading on the US consumer heightened concerns about the health of the world’s largest economy. The US dollar index also retreated after Treasury Secretary Scott Bessent indicated that US yields and the dollar would decline further due to Trump’s policies, even if the Federal Reserve (Fed) kept interest rates on hold. However, both the dollar and Treasury futures reversed course after House Republicans passed a budget blueprint, paving the way for $4.5 trillion in tax cuts.

The fluctuations in macroeconomic and political developments are keeping investors on edge, leading to volatility in financial markets. Concerns over economic growth in the US deepened on Tuesday when a closely watched measure of consumer confidence suffered its steepest decline since August 2021, reflecting uncertainty about the broader economic outlook. This prompted traders to increase bets on Fed rate cuts this year, despite signs of mounting inflationary pressures. Treasury yields fell to their lowest levels in 2025, while a gauge of megacap stocks extended its decline from its peak to over 10%. Meanwhile, Bitcoin and the wider cryptocurrency market suffered substantial losses, and the US dollar index closed below its 100-day moving average for the first time since October 2024. Many of these sharp movements appear to be a reversal of the "Trump trade" narrative, with growing concerns over weakening US consumer activity bolstering expectations of Fed policy easing.

However, the proposed tax cuts have halted the decline in equities and the dollar, while Treasuries have stabilised. Republicans have defended the cuts, arguing they will stimulate economic growth and, alongside other Trump measures such as tariffs, help contain the deficit. The renewed focus on fiscal policy could temporarily support the dollar and divert attention from weak consumer activity—at least until tariffs take centre stage again next week.

Euro Struggles at $1.05

The euro has posted a notable recovery against the US dollar in February, having rebounded from a more than two-year low earlier in the month. EUR/USD has climbed roughly 4%, rising from near $1.01 to testing the key psychological resistance level of $1.05, though it remains six cents below its five-year average.

A cyclical downturn in the US dollar has played a significant role in this rebound, with soft US economic data disappointing investors and aiding the euro’s recovery. However, fundamental economic indicators in the US remain relatively robust. Reports of a possible peace agreement in Ukraine have also provided modest support to the euro, primarily through increased military spending due to heightened security concerns, as well as lower gas prices easing energy cost pressures. Meanwhile, tariff fatigue has allowed risk appetite to improve, further benefiting the pro-cyclical euro. However, while the outcome of Germany’s recent election has provided some relief, it has yet to deliver a meaningful boost to the currency.

Stability in bond markets has also failed to lift the euro. The typical inverse relationship between EUR/USD and the MOVE index (a measure of fixed income volatility) diverged around the US election. The index has since declined by approximately 16% and is now trading near its lowest levels since early 2022. Under normal conditions, such a move would be expected to push EUR/USD above $1.10.

Yet, foreign exchange markets are driven by a multitude of factors, and their relative influence fluctuates over time. EUR/USD’s recent difficulty in breaking decisively above $1.05 suggests that expectations of a sustained rally may hinge on a more pronounced downturn in the US economy, the timing of which remains uncertain.

Sterling Lacks Fresh Catalysts Against the Euro

Sterling rallied to near its highest level of 2025 against the euro last week and remains more than two cents above its year-to-date low of €1.18, well above its five-year average of €1.16. GBP/EUR has maintained a steady upward trend for the past two years, experiencing only six months of modest declines over this period and gaining nearly 8% overall. While there are reasons to anticipate further gains in 2025, the lack of a fresh positive catalyst could limit sterling’s upside potential.

While excessive euro pessimism appears to have stabilised, the broader European economic and political backdrop remains unfavourable for the currency. Although the UK economy is projected to grow by approximately 1% this year, recent data has been relatively encouraging. In contrast, the Eurozone is expected to expand by around 0.9%, with increased US protectionism weighing on growth prospects in both regions. If and how President Trump implements his tariff threats remains uncertain, but under most scenarios, the UK is likely to be less affected than the Eurozone, given that a significant portion of UK exports to the US are in services. Political uncertainty is also higher across Europe compared to the UK, though Germany’s election outcome has raised hopes for pro-growth structural reforms in Europe’s largest economy.

The most significant factor supporting GBP/EUR is interest rate differentials. The European Central Bank (ECB) is expected to implement deeper interest rate cuts than the Bank of England (BoE) this year, given the UK’s still-elevated wage growth and services inflation. However, much of this expectation is already priced into the exchange rate, and real interest rate differentials (accounting for inflation) suggest that €1.19 is a fairer valuation.

What does this mean for the future of sterling against the euro? Absent any major shifts in the outlined fundamentals—slightly stronger UK growth, reduced political uncertainty, and fewer BoE rate cuts—GBP/EUR should remain supported, with no major trend reversal anticipated in the near term. However, the currency pair continues to encounter resistance around €1.21, which marks the upper limit of its post-Brexit trading range since 2016. A decisive breakout above this level would be necessary to establish a new higher trading range.

Dip buyers come to the rescue

Dip buyers come to the rescue

Yesterday’s market session unfolded in two distinct phases, as investors began the week by selling risk assets amid growing concerns of a slowdown in the United States. Recession fears intensified following weaker-than-expected leading indicators from the Chicago and Dallas Federal Reserves. US equities declined, bond yields plummeted, and the dollar followed suit, weighed down by worsening sentiment.

However, dip buyers stepped in during the US session, helping equities and the greenback recover some losses. Overall, the impact of the day’s news and data appeared to be neutral for the markets. That said, recent concerns about economic growth could pose a greater risk to assets if weak economic data persists, making secondary indicators increasingly important to monitor.

The dollar ended the day slightly lower after briefly touching its weakest level since mid-December. As highlighted in our feature for Fortune, the dollar remains under pressure for two key reasons: the absence of new tariffs, which has reduced safe-haven demand, and the Federal Reserve’s pause, which is tied to rising inflation expectations rather than strong macroeconomic data. With recent data reaffirming these trends, the dollar has struggled to benefit from stable interest rates, currently sitting at its lowest level this year, down 3.4% from January’s peak.

For a meaningful rebound, dollar bulls will require either stronger US economic data or renewed tariff enforcement by Trump. The latter could materialise today, as Trump reiterated overnight that tariffs on Canadian and Mexican goods will be implemented once the delay expires.

New government, old challenges

The euro briefly climbed above $1.05, reaching its highest level in nearly a month before retreating to $1.0460. Investors see the potential for increased fiscal spending, particularly in defence, as a means of supporting economic activity. However, fiscal constraints may limit the impact, as political obstacles complicate efforts to increase spending. Meanwhile, business sentiment is displaying cautious optimism, though immediate economic conditions remain subdued. We will continue to monitor political developments and key macroeconomic releases, as they will play a crucial role in shaping the near-term direction of EUR/USD.

Following the outcome of the German election, Chancellor-designate Friedrich Merz is actively engaging with the Social Democrats (SPD) to accelerate defence spending in response to escalating geopolitical tensions. However, the rise of fringe parties, securing a minority with blocking rights, has complicated efforts to amend the constitutional “debt brake,” which restricts government borrowing. To navigate these constraints, Merz is considering pushing through reforms in the current parliament before the new session begins on 24 March. These political manoeuvres have added uncertainty to the euro’s performance, as markets assess their potential economic impact.

On the macroeconomic front, the Ifo Institute’s latest survey indicates a modest improvement in business expectations, with the index rising to 85.4 in February, up from 84.3 in January, and exceeding forecasts of 85.0. However, current conditions deteriorated, highlighting that while businesses are hopeful about the future, they continue to struggle with present challenges.

Pound facing resistance

Sterling climbed to a nine-week high of $1.2690 before encountering resistance near $1.27. Strong UK data and persistent inflation in recent weeks continue to provide support, leaving room for further gains—especially if US economic momentum slows in tandem.

However, geopolitical risks remain a key factor. Trump’s tariff agenda, while not directly targeting the UK, could disrupt global trade flows, particularly with China and the eurozone, leading to potential knock-on effects for Britain. Meanwhile, elevated UK inflation continues to support sterling, but a renewed rise in gilt yields—towards January highs—could shift rate expectations from a tailwind to a headwind if fiscal concerns resurface.

This morning, the pound is trading in the lower $1.26 range, as a risk-off mood takes hold following Trump’s overnight comments. The administration is set to raise tariffs on major trading partners and is considering further restrictions on China’s access to advanced chips, adding fresh uncertainty to the markets.

FX Market Movers: Euro Stumbles, Sterling Shines, and Dollar Dips

EUR/USD: Euro Struggles as Monetary Policy Diverges

The euro is under sustained pressure against the US dollar, with forecasts suggesting EUR/USD could slip below parity this year. The primary driver behind this bearish outlook is the widening gap in monetary policy between the European Central Bank (ECB) and the US Federal Reserve. While markets anticipate some rate cuts from the Fed later in the year, the ECB is expected to ease policy more aggressively, with at least three rate reductions projected by mid-year.

Compounding the euro’s weakness is the sluggish economic performance in the eurozone. Recent data, including a sharp decline in France’s Purchasing Managers’ Index (PMI) to a 17-month low, underscores a persistent slowdown in manufacturing and services. This downturn fuels expectations of further ECB intervention, reinforcing downward pressure on the single currency. Additionally, uncertainty surrounding US trade policy under President Donald Trump has cast a shadow over European exports, adding another layer of risk for the euro.

Despite a recent pullback, the US dollar remains fundamentally supported by stronger economic growth and higher interest rate differentials. Robust US labour market data and consumer spending continue to underpin the greenback, further tilting capital flows in favour of US assets. As a result, EUR/USD looks set to remain under pressure in the coming months.

GBP/EUR: Sterling Holds Firm Despite German Political Developments

The pound maintains a bullish stance against the euro, although early-week movements may be influenced by the outcome of Germany’s latest elections. The centre-right CDU/CSU, led by Friedrich Merz, emerged victorious, but with limited leverage over its coalition partner, prospects for significant economic reforms remain uncertain. While the election result was broadly as expected, the absence of a far-right surge provided relief to markets, offering some temporary support to the euro.

Despite this, euro strength is likely to be capped as coalition negotiations progress, with a new government unlikely before April. This political limbo, combined with ongoing economic concerns in the eurozone, suggests any post-election gains for the euro may be short-lived. The pound’s recent dip to 1.2050 against the euro could see further declines towards 1.2020 or even 1.20 in the early part of the week, though these levels may attract dip buyers.

Looking ahead, attention turns to key speeches from Bank of England (BoE) policymakers, including Deputy Governor Clare Lombardelli and Chief Economist Huw Pill. With market expectations for rate cuts fluctuating, any dovish rhetoric from BoE officials could weigh on sterling. However, the broader outlook remains constructive, with GBP/EUR potentially revisiting last week’s high of 1.2097 before the week is out.

GBP/USD: Sterling Strengthens as Dollar Momentum Eases

The pound surged to a two-month high against the US dollar, with GBP/USD climbing above 1.2600. A third consecutive weekly decline for the greenback helped fuel the pair’s rally, as investors remained unconvinced by the Federal Reserve’s hawkish stance. While the Fed minutes reiterated a cautious approach to rate cuts, softening US economic data, including a weaker-than-expected PMI reading, dampened dollar demand.

Adding to the market uncertainty, geopolitical tensions escalated as the US excluded Ukraine and the EU from peace negotiations with Russia, prompting concerns over Europe’s strategic position. However, these developments failed to provide the expected boost to the dollar, with investors instead turning to gold and equities as safe-haven assets.

In the UK, stronger inflation and labour market data supported the pound, despite expectations of BoE rate cuts later this year. Retail sales rebounded sharply in January, while inflation surprised to the upside at 3%, reinforcing the argument that the BoE may proceed cautiously with rate reductions. With a relatively light data calendar for the UK this week, focus will remain on BoE and Fed speeches, along with key US economic releases, including GDP and PCE inflation data, which could provide further direction for GBP/USD.

Geopolitical uncertainty in focus

US Shifts Stance on Russia and Ukraine as Economic Uncertainty Grows

The United States has recently adjusted its position on Russia and Ukraine, suggesting it may ease sanctions in exchange for negotiations to end the conflict. Meanwhile, former President Trump has ramped up pressure on Ukraine, labelling President Zelensky a “dictator” after a $500 billion mineral rights deal fell through due to Ukraine’s reluctance. This shift has unsettled European allies, who are now considering establishing a security force for Ukraine but require US support to move forward.

Simultaneously, economic uncertainty is increasing as the Federal Reserve evaluates the impact of Trump’s policies on trade, immigration, and government spending. Raphael Bostic, President of the Atlanta Federal Reserve, expects two interest rate cuts in 2025. However, businesses are growing concerned about rising costs driven by tariffs and labour shortages caused by mass deportations. Inflationary pressures are also building, with key Consumer Price Index (CPI) and Producer Price Index (PPI) figures accelerating, while recent surveys from the New York and Philadelphia Federal Reserve banks point to increasing price pressures.

As a result, investors have significantly lowered their expectations for interest rate cuts from the Fed, now predicting fewer than one this year. Despite this, the US dollar has not strengthened, likely due to two main reasons: first, the absence of new tariffs has reduced demand for the currency as a safe haven and lowered the trade premium; second, the Fed’s decision to pause rate adjustments is based on rising inflation expectations rather than stronger economic data. Recent economic reports have reinforced these trends, preventing the dollar from gaining momentum. The Greenback has now dropped to its lowest level this year, down 3.4% from its January peak. As previously noted, a sustained dollar rebound would require either continued tariff enforcement by Trump or stronger economic performance.

Sterling Strengthens as UK Wage and Inflation Data Outperform US Outlook

The British pound continues to gain against its counterparts, driven by robust wage and inflation figures that contrast with a weakening US economic outlook. GBP/USD has risen to $1.2660, marking its third consecutive weekly advance, while falling oil and gas prices have provided additional support to the energy-reliant pound.

Recent UK data revealed that wage growth reached an eight-month high in December at 6.0% (6.2% in the private sector), while unemployment remained steady at 4.4%. Inflation also surged to 3% in January, fuelled by rising food and airfare costs, increasing pressure on the Bank of England. Although markets anticipate 50 basis points of rate cuts by the end of the year, sterling remains buoyed by a more favourable trade environment compared to the euro and the US dollar.

Pound Surges as Strong Retail Sales and Budget Surplus Reduce Rate Cut Expectations

The Pound-to-Euro exchange rate (GBPEUR) climbed to 1.2080 after the Office for National Statistics (ONS) reported a 1.7% month-on-month rise in retail sales for January, far surpassing expectations of 0.3% and recovering from December’s disappointing -0.6%. Meanwhile, the Pound-to-Dollar exchange rate (GBPUSD) reached a new two-month high of 1.2678 as markets scaled back expectations of a Bank of England rate cut in March. Retail sales are now up 1.0% year-on-year, exceeding the 0.6% forecast.

The UK government recorded a £15.44 billion budget surplus in January, driven by a record £117.6 billion in tax revenue, £7.8 billion higher than in January 2024. A key contributor was a surge in self-assessment tax receipts, which reached £36.2 billion—the highest January figure on record.

The pound continues its short-term recovery on the back of these strong economic indicators, as markets now anticipate just two interest rate cuts this year. The solid retail sales figures suggest that excessive monetary easing could further fuel inflationary pressures.

This follows ONS data showing that UK inflation unexpectedly rose to 3.0% year-on-year in January, with economists warning it could surpass 4.0%. This would make it increasingly difficult for the Bank of England to justify rate cuts while inflation remains well above the 2.0% target.

The resilience in retail sales reflects strong wage growth and a robust labour market. However, this trend could shift in the spring, as businesses face higher costs from national insurance hikes and an increase in the minimum wage.

European Markets Decline Amid Geopolitical Uncertainty and Economic Shifts

European markets fell today as investor sentiment weakened due to geopolitical uncertainty and evolving economic expectations. Equities declined, with healthcare and energy stocks leading the losses, despite Eurozone consumer confidence rising to -13.6 in February—its highest level in four months and above forecasts. Optimism persists as markets anticipate further rate cuts from the European Central Bank (ECB), with expectations of a 25 basis-point reduction at each of the next three meetings, potentially bringing the deposit rate below 2% by 2026.

These economic developments are unfolding against a backdrop of increasing geopolitical tensions, particularly in Germany, where the upcoming election could reshape European leadership. Conservative challenger Friedrich Merz has reiterated his support for Ukraine, while the UK and France are working on plans for a European-led “reassurance force” to help protect Ukraine if a ceasefire with Russia is reached.

With Germany’s general election approaching later this week, uncertainty remains high. However, the euro has gained support from broader US dollar weakness and soft economic data from the US. EUR/USD is currently testing the $1.05 level, with a potential break targeting $1.0540. Today’s Purchasing Manager Indices (PMIs) will be crucial—further signs of economic stabilization could improve sentiment toward the euro.

GBP/EUR target range extended

Pound-to-Euro Exchange Rate Eyes Three-Year High Amid Interest Rate Dynamics

The Pound-to-Euro exchange rate is on track to reach a fresh three-year high in the coming months, supported by elevated UK interest rates. However, the pace of this ascent may be gradual as investor bets on further rate cuts in the Eurozone cool.

Overnight indexed swaps, which reflect market expectations for central bank interest rates, now indicate just two more rate cuts from the Bank of England in 2024—down from four anticipated just weeks ago. This repricing has strengthened the Pound, pushing GBP/EUR from January lows of 1.18 to 1.2090 by midweek.

Recent UK economic data has reinforced the Bank of England’s cautious stance, with inflation unexpectedly rising to 3.0%, surpassing forecasts of 2.8%. The central bank had previously signalled a preference for cutting rates quarterly, but money markets now suggest that pace may be too aggressive given persistent inflationary pressures. Some economists even predict UK inflation could reach 4.0%, driven by rising fuel prices, goods costs, and the government's upcoming tax and minimum wage hikes.

Whether GBP/EUR can push further toward 1.22 will also depend on the European Central Bank’s (ECB) rate decisions. If the ECB slows or pauses its rate-cutting cycle, the narrowing interest rate differential between the UK and Eurozone could limit the Pound’s upside. ECB board member Isabel Schnabel recently suggested the central bank might hold off on further cuts, raising uncertainty over the Euro’s trajectory.

The ECB has already lowered rates five times since June in response to sluggish Eurozone growth, but renewed inflation concerns and geopolitical risks, such as trade tensions, could alter its course. Currently, the ECB’s key rate stands at 2.75%, down from 4% in September 2023, with markets pricing in at least two more cuts this year. However, if expectations for a third cut diminish, Euro rates could adjust more hawkishly than UK rates, potentially slowing GBP/EUR gains.

Euro in Trump’s Grip as US Policy Shift Reshapes European Outlook

The euro remains heavily influenced by US President Donald Trump, whose daily remarks continue to drive sentiment and movement in the common currency. Trump has reportedly pressured Ukrainian President Zelenskiy to make peace with Russia swiftly or risk losing US support entirely. By sidelining Kyiv and Brussels in negotiations, the US is signaling a significant shift in diplomacy, leaving Europe’s geopolitical future uncertain.

This development overshadowed hawkish remarks from ECB Board Member Isabel Schnabel, who urged caution on rate cuts amid growing inflation concerns and tariff threats. German bond yields responded, with the 10-year Bund climbing to a three-week high of 2.55%.

Today's market focus will turn to three scheduled Federal Reserve speakers, US jobless claims, the Philly Fed Index, and European consumer confidence data. For EUR/USD to attempt a retest of $1.05 this week, it will need to maintain support above $1.04.

Please note:  The news and information contained on this site should not be interpreted as advice or as a solicitation to offer to convert any currency or as a recommendation to trade.

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