Tariff Tensions and Dollar Volatility.

  • USD Volatility Returns: Trump’s first day as U.S. President saw the dollar drop before the inauguration due to reports of no immediate tariffs, followed by a rebound after hints of a 25% tariff on Canada and Mexico. Markets remain cautious, with DXY down 0.7%.
  • Tariff Risks for CAD & MXN: Canada and Mexico face potential downside as Trump’s tariff threats loom, with USD/CAD expected to rally above 1.45. Canada has outlined retaliatory plans, but political uncertainty adds pressure.
  • EUR/USD Undervalued: EUR/USD is trading 1.5% below fair value despite a rebound, supported by staying out of tariff discussions. However, weak fundamentals and recession concerns cap its upside potential.
  • GBP Stays Stable: UK labour data showed modest wage growth, aligning with BoE’s expectations of a February rate cut. EUR/GBP may see short-term gains as markets price in further BoE easing.
  • Headline-Driven Trading Ahead: With Trump’s executive orders in focus and the Fed in a quiet period, expect market moves driven by news and tariff-related risks, favoring short-term dollar strength.

USD: Volatility Takes Center Stage
Donald Trump’s first day back as U.S. President brought significant FX market swings. The dollar dropped before his inauguration following media reports suggesting no immediate tariff implementation. This decline was likely amplified by large dollar-long positions and thinner market liquidity due to the U.S. holiday.

Among Trump’s initial executive orders, he established the External Revenue Service to handle tariffs and duties, declared national emergencies at the border and in energy, and rolled back parts of Joe Biden’s green energy policies. Later, Trump hinted at a 25% tariff on Canada and Mexico by February 1, triggering a dollar rebound as CAD and MXN lost daily gains.

Currently, markets remain cautiously optimistic, with the DXY index down 0.7% since Friday. European currencies and China-linked currencies (AUD, NZD) are benefiting from the lack of immediate widespread tariffs. However, CAD and MXN could face more downside if Trump follows through. Canada, amid its political transition, has prepared retaliatory tariff plans targeting U.S. industries.

USD/CAD reflects just over a 2% risk premium, signaling markets haven’t fully priced in the tariff risk. With limited influence from today’s Canadian CPI data, USD/CAD could rally above 1.45. Meanwhile, dollar net-long positions remain elevated, nearing levels last seen in June 2019, suggesting potential for further dollar strength amid “headline trading” and noise-driven moves.

EUR: Short-Lived Relief in Crosses
Despite a rebound, EUR/USD remains undervalued by approximately 1.5%, reflecting lingering tariff-related risks. While the euro could benefit if Europe stays out of Trump’s tariff discussions, this reprieve may be short-lived given protectionist surprises and Europe’s fragile macroeconomic fundamentals.

Today’s German ZEW survey will offer insights into the economic mood, but expectations remain subdued, aligned with the ongoing recessionary outlook. EUR/USD may struggle to climb past 1.050.

GBP: Muted Reaction to Jobs Data
UK labour market figures had little impact on EUR/GBP. Wage growth (excluding bonuses) exceeded expectations, but private sector pay, closely monitored by the Bank of England (BoE), rose modestly. Cooling trends in wage growth and unreliable unemployment figures suggest a softer job market, aligning with the BoE’s outlook for a February rate cut.

Short-term, EUR/GBP faces upside risks due to potential BoE easing and UK-specific challenges. Simultaneously, the euro may gain slight support if Trump continues to steer clear of Europe in his tariff plans.

*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.