Dollar Drama: Trade Tensions, Deficit Dangers, and a Euro on the Rise.
USD under pressure from renewed trade tensions, deficit concerns, and a disconnect from traditional drivers like rates and equities.
Fair value models suggest USD is undervalued, but it continues to trade more like an emerging market currency.
EUR gains support from its safe-haven appeal during US policy drama, with Lagarde promoting a stronger global euro role.
GBP/USD surged to a 3-year high last week, driven by solid UK data and mounting worries over US debt and fiscal policy.
Focus this week shifts to key US economic indicators like consumer confidence, durable goods, PCE inflation, and GDP for clues on the dollar’s direction.
USD: Trade Hangover and Deficit Fears Weigh Heavily
It’s no shock that the US dollar started the week on a softer note, despite President Trump walking back on a 50% EU tariff threat. The market had largely processed tariff concerns as April’s issue, anticipating that May would be about trade deals. But Trump’s renewed clash with the EU reminds investors that tariff risks are never far off. April showed that when trade drama flares up, the dollar tends to suffer most.
According to our fair value model—based on FX correlations with rates and equities—the dollar remains significantly undervalued (4% vs EUR, GBP, CAD; 3% vs JPY, AUD). Still, current trading doesn’t reflect those fundamentals. Instead, the greenback is behaving more like an emerging market currency: driven by deficit concerns, erratic policy, and jittery capital flows. Supporting this decoupling, the correlation between 10-year Treasury yields and the DXY index has collapsed from 0.68 in January to zero.
For the dollar to stabilise, data needs to start calming recession fears. Deficit anxieties are making the greenback’s footing even shakier. As highlighted by James Smith, the missed opportunity to tackle the deficit in Trump’s new spending bill could keep creditworthiness concerns in the spotlight, especially as weak Treasury auction demand lingers.
Today’s release of the Conference Board Consumer Confidence Index (forecast: ~87) and April’s durable goods orders (expected to dip) will be closely watched. The greenback may need a confidence reading above 90 to meaningfully reprice growth optimism. The rest of the week brings personal income data, the PCE price index, and Fed minutes—all potentially market-moving.
With US and UK markets closed Monday, FX liquidity was thin. As volume returns, we lean bearish on USD in the near term, unless US data surprises to the upside. A retest of April’s 98.0 low in DXY looks more probable than a rebound to 100.
EUR: Big Ambitions Face Political Reality
The euro has weathered the latest US tariff episode with ease—another reminder that, in times of US trade drama, investors often shift toward the euro. EUR/USD touched 1.1420 before pulling slightly back, and could grind higher as volumes normalise.
ECB President Christine Lagarde added fuel to the bullish fire, floating the idea of a “global euro moment.” Her push for the euro’s broader international role helped stoke interest, especially from those viewing EUR/USD as strategically overvalued. Lagarde sees benefits: a globally-used euro would anchor rates and stabilise bond markets. But exporters and fiscally conservative governments may resist, wary of an overly strong currency.
The real hurdle, however, is structural. Competing with the dollar requires consistent joint EU debt issuance—not just ad hoc moves like during the pandemic. Without political unity, hopes for a global euro may be premature. That said, any concrete steps toward deeper integration could still lift EUR/USD.
Eurozone data remains light until Friday’s CPI prints from Germany, Spain, and Italy. If US deficit concerns persist, EUR/USD could test 1.150 before likely settling back toward 1.130 by late June.
GBP: Strong Data Keeps Pound Flying High
This week starts with the CBI distributive trades survey, which could provide an early lift to the pound. UK data thins out after that, so US economic releases will take the spotlight—including durable goods orders, Fed minutes, GDP estimates, and Friday’s core PCE inflation figure.
If US data disappoints or hints at inflation cooling, markets could ramp up Fed rate cut bets, pushing USD lower and GBP/USD higher.
WEEKLY RECAP: GBP/USD Surges on Strong UK Data and US Debt Woes
The pound-dollar exchange rate hit a three-year high at $1.3496 last week—up 1.6%—on US debt worries and upbeat UK data.
GBP gained early as a UK-EU trade deal boosted growth projections by £9bn. Mixed BoE commentary and a CPI jump to 3.5% briefly added volatility, but retail sales crushed expectations (1.2% vs. 0.2%), reinforcing economic strength.
Meanwhile, USD suffered from Moody’s downgrade of US credit, stalled trade talks, and fears over Trump’s deficit-heavy tax and spending package. Even a market risk-off shift and better-than-expected PMI data on Thursday couldn’t fully rescue the greenback.