USD Stumbles as Europe Surges.

USD: Market Doubts Weigh on the Dollar

Yesterday’s FX market saw dramatic moves in European bond yields, with German yields spiking 30 basis points—the biggest one-day jump in 25 years—following Germany’s fiscal spending announcement. While we dive into the euro’s outlook below, this shift also has major implications for the dollar. What’s surprising is how disconnected US yields remained, with Treasuries barely moving. This suggests investors are rethinking US exceptionalism compared to Europe.

Meanwhile, US trade policy developments continue. The USMCA exemption for autos signals protectionist moves, yet markets seem unconvinced that fresh tariffs will have a lasting impact. Mexico appears closer to a deal to pause tariffs than Canada, which could lead to the Mexican peso outperforming the Canadian dollar. However, both currencies have strengthened as market sentiment around the US weakens.

US data remains more critical than tariff news this week. Tomorrow’s payrolls report is expected to show only 120k jobs added (vs. a 160k consensus), following a weak ADP report. While ISM services data came in stronger than expected at 53.5, any dollar gains were overshadowed by softer labor expectations.

Today’s focus is on the US trade deficit, which is expected to widen further. This could provoke a stronger stance on tariffs from the US administration. However, with payrolls data looming, we’re not calling for an immediate dollar rebound. While the USD has been battered in March, we believe the decline is overdone. A stabilization around 104-105 on the DXY may be the best outcome for dollar bulls in the near term.

EUR: Euro Surges on Germany’s Fiscal Shift

Germany’s decision to ramp up fiscal spending with a €900bn package has triggered a seismic shift in European markets. A sharp 40bp selloff in German bunds was echoed across EU sovereign debt, signaling expectations of rising deficits, higher inflation, and stronger growth. Our rates team believes these moves are unlikely to reverse soon, with 10-year bund yields possibly heading toward 3%.

For the euro, the impact is massive. EUR/USD has surged to 1.08, marking a 3%+ rally in two sessions. Notably, short-term valuation risks remain modest, as the euro’s gains have been supported by a sharp tightening in the 2-year swap rate differential. Markets are simultaneously pricing in a more hawkish ECB and a more dovish Fed—a rare divergence that has driven EUR/USD higher.

That said, we’re hesitant to call the top just yet. Two major events could shape the euro’s path: today’s ECB meeting and tomorrow’s US payrolls report.

While the ECB is widely expected to cut rates by 25bp, its messaging will be critical. If President Lagarde signals rising inflation risks due to fiscal expansion, it could bolster the euro further. A push toward 1.10, however, may be unrealistic given potential US tariffs on the EU and rate differentials. We still see a 1-1.5% correction in EUR/USD in the short term, with volatility remaining high.

GBP: Pound Slides as Euro Strengthens

The British pound has struggled against the euro, with GBP/EUR dropping to 1.1937—the lowest level since January. This decline follows Germany’s massive fiscal commitment to infrastructure and defense, which has sent German bond yields soaring.

Incoming German Chancellor Friedrich Merz framed the spending as essential for security, stating, “Whatever it takes” now applies to defense. Investors have responded by pouring into German bonds, pushing yields higher and boosting the euro.

As a result, GBP/EUR suffered its largest single-day loss in five months on Wednesday, bringing the week’s decline to 1.55%. The euro’s rally has extended across the board, with gains against the pound, Swiss franc, and Japanese yen.