Tariff Tensions and Currency Caution: USD Feels the Heat.

  • Tariff risks are undermining the dollar’s safe-haven appeal, as defensive flows favour European currencies.

  • EUR/USD strength is being driven more by hedging and capital flows than by interest rate differentials.

  • Yen gains may not be sustainable due to political instability and fiscal expansion risks in Japan.

  • Sterling carries a risk premium, partly due to euro strength and partly due to UK fiscal concerns.

  • Markets may become more reactive to trade-related news as the 1 August deadline approaches.

USD: Dollar Dented by Tariff Anxiety
The dollar started the week on the back foot, with no immediate trigger to blame. Long-term Treasury yields continued to drop, but not more sharply than their European counterparts. EUR/USD’s recent rise seems to reflect a cautious shift in positioning rather than a clear interest rate story—markets are wary of a possible no-trade-deal outcome as the 1 August deadline looms. In this climate, the dollar’s traditional safe-haven appeal appears diminished, while European currencies are gaining favour amid growing tariff-related uncertainty.

A broader drag on the greenback may also come from unwinding long USD/JPY positions. However, we view the yen’s recent rally as potentially short-lived. Prime Minister Shigeru Ishiba’s weak political standing and ongoing pressure for fiscal stimulus continue to weigh on Japanese government bonds. Even if a US-Japan trade deal materialises, the bond market remains fragile.

On the data front, it’s a quiet week in the US. June’s leading index fell by 0.3%, in line with forecasts. Upcoming regional manufacturing data from the Philadelphia and Richmond Feds are unlikely to stir much reaction. Still, with the 1 August trade deadline fast approaching, FX markets may become more sensitive to tariff headlines. While we maintain a constructive medium-term view on the dollar—supported by a potential hawkish repricing of the Fed—any escalation in trade tensions could still pressure the DXY lower in the short term.

EUR: Holding Steady Amid Trade Jitters
Speculative positioning on the euro has climbed, with net longs at 15.6% of open interest—the highest since January. But considering the euro’s 10% climb from early 2024 levels, this figure suggests the bulk of EUR/USD strength is being driven by capital and hedging flows rather than outright speculation.

Concerns about a no-deal scenario in US-EU trade talks are building. Some EU members are reportedly considering retaliatory tariffs, a move likely to provoke the US. Even a temporary tit-for-tat escalation could be disruptive. Whether the euro remains the preferred pick over the dollar will depend on how far the situation escalates and whether the EU is seen as the loser while others strike deals with Washington.

Domestically, the euro isn’t under pressure from trade policy, and markets aren’t expecting a more dovish ECB at Thursday’s meeting. A rate cut isn’t anticipated until December. Still, we don’t see enough momentum to push EUR/USD back to its early July highs (around 1.180). A more realistic anchor sits closer to 1.160, especially if the Fed turns more hawkish.

GBP: Risk Premium Persists
UK economic data hasn’t validated talk of a more aggressive pace of Bank of England cuts. Two-year swap rates are rebounding, and expectations remain for one cut in August and another in December—consistent with our base case.

Even with the recent shift in short-term rate differentials back in favour of the pound, EUR/GBP has held firm. This suggests the market is assigning a risk premium to GBP—currently estimated at about 0.8% overvaluation. While not extreme, it’s nearing the top of the normal valuation range.

This risk premium is partly explained by the euro’s strength, but UK-specific concerns are also at play. June borrowing figures came in significantly above forecasts (£20.7bn), which will fuel speculation about tax hikes in the autumn budget. Although the pound hasn’t reacted significantly to the data, such fiscal headwinds could limit any upside for GBP going forward.

*All rates shown are indicative of interbank rates and should only be used for indication purposes only. It is important to note that foreign exchange rates fluctuate and that rates may vary depending on the amount and the base currency that is purchased or sold. Rates are correct as of 8:00am UK time. CentralFX are not responsible for the rates shown.