Tariff Confusion, Dollar Dips, and GBP Treads Lightly.

• USD: Markets relieved that reciprocal tariffs were not immediate, though execution remains uncertain. Short-term dollar weakness is seen as a correction.
• EUR: Tariff delay supports EUR/USD in the near term, but gains are expected to be limited, with a forecast of 1.00 in Q2.
• GBP: Despite stronger-than-expected GDP data, concerns remain over economic growth and potential further BoE rate cuts.
• Trade Policy: Trump’s tariff strategy is complex, with potential major implications for key US trade partners, particularly the EU.
• Market Focus: Attention shifts to Munich’s security conference and potential US-Russia-Ukraine talks in Saudi Arabia.

USD: Reciprocal Tariffs Leave Markets Unconvinced

The US dollar is slightly weaker in European trading today, influenced by lower US interest rates, optimism around a potential resolution to the war in Ukraine, and the unveiling of a US reciprocal tariff package that has left many puzzled.

Markets had anticipated a major trade report from the Commerce Department in April, followed by tariff announcements. However, there were concerns that this week’s announcement would be a separate, immediate action. Yesterday’s clarification that it was merely laying the groundwork for April has been taken as a relief.

While President Trump’s objectives for reciprocal tariffs are clear, the implementation details are overwhelmingly complex. Each tariff will be calculated based on a country’s import tariffs, VAT, subsidies, regulatory barriers, FX misalignment, and any other perceived restrictions on fair competition with the US. Given the push to downsize government agencies, it’s unclear how the Commerce Department will produce a comprehensive report on all trading partners by April.

The likely outcome? Potentially steep tariffs targeting key US trade deficit partners, with the EU in particular at risk due to its digital service tax. However, markets had already factored in peak trade pressures for Q2, and this latest development aligns with that expectation. As a result, the current dollar weakness is seen as a temporary correction rather than a major shift.

For now, attention turns to the security conference in Munich, where discussions on Ukraine could impact market sentiment. Speculation is growing about a possible high-level meeting in Saudi Arabia involving US, Russian, Ukrainian, and European officials. A weak US retail sales report for January—partly attributed to poor weather—is unlikely to significantly impact the dollar. In the short term, DXY could slip further to the 106.35 range.

EUR: Limited Room for Further Gains

Yesterday’s US Producer Price Index (PPI) data, which feeds into the core PCE inflation measure, came in softer than expected, lowering US rates and strengthening EUR/USD. The lack of immediate tariff action has also given trading partners time to adjust—whether by increasing US LNG imports, lowering their own trade barriers, or preparing to push back.

Current EUR/USD momentum suggests a possible extension to the 1.0535/75 range, but gains beyond that seem unlikely. In the longer term, the euro is expected to weaken, with a forecast of EUR/USD testing parity (1.00) in Q2.

There has also been speculation that strong eurozone equity performance could support the euro. However, inflows into major eurozone equity ETFs, such as the iShares MSCI Eurozone fund, remain lackluster. This further supports the view that EUR/USD’s rally will likely stall above 1.05.

GBP: Cautious Trading Amid Economic Uncertainty

The British pound is trading cautiously against major currencies, with investors weighing mixed economic signals. Despite surprisingly strong GDP data for December (+0.4%) and Q4 2024 (+0.1%), the overall UK economic outlook remains fragile.

The Bank of England (BoE) recently slashed its 2024 GDP forecast to 0.75%, a setback for Chancellor Rachel Reeves, who has emphasized economic growth. The BoE also warned that rising global tariffs could further slow UK growth.

Looking ahead, key data releases next week will be pivotal for GBP. The labor market report (Tuesday) and January’s Consumer Price Index (Wednesday) will shape expectations for the BoE’s next move. Markets are already debating whether the central bank will cut rates again in March, following its 25bps reduction to 4.5% earlier this month.