Tariffs, Tech, and Shifting Market Dynamics.
- USD Struggles as Safe Haven: The global equity selloff, triggered by Chinese startup DeepSeek’s AI model announcement, saw traditional safe havens (JPY, CHF) outperform the dollar, while risk-sensitive currencies (AUD, NZD, NOK, CAD) weakened.
- Tariff Threats Lift Dollar: Trump reignited protectionism fears with plans for universal tariffs, starting at 2.5% and potentially rising to 20%, targeting key products like steel and semiconductors. This added a persistent risk premium to the dollar.
- EUR Under Pressure from Tariffs: Rising tariff concerns overshadow the ECB’s expected 25bp rate cut, leaving the euro vulnerable. EUR/USD undervaluation has widened, with further downside possible as markets price in greater risks.
- GBP Positioning Opens Recovery Potential: Investors are net short on the pound for the first time since May 2024, reflecting sentiment shifts due to weak economic data. However, this clears overhang and positions GBP for potential recovery.
- Markets Watch for Central Bank Signals: Equity volatility, protectionism, and inflation risks remain key drivers. Tariff concerns may sustain dollar strength unless central banks, particularly the Fed and ECB, signal changes in policy.
USD: Tariffs Reignite Protectionism Fears
This week was expected to shift FX markets’ attention back to central bank developments, but instead, geopolitical and economic events have dominated. Chinese startup DeepSeek’s unveiling of an affordable AI model has rattled U.S. tech giants, triggering a global equity selloff.
Interestingly, the U.S. dollar has struggled to act as a reliable safe haven during the stock market turmoil, with markets focusing on the potential impact on American consumers and an uptick in dovish expectations for the Federal Reserve. As risk-sensitive currencies like AUD, NZD, NOK, and CAD weakened, traditional safe havens such as the JPY and CHF gained favor over the USD.
However, the dollar staged a late comeback yesterday after Trump reignited the tariff debate. Reports from the Financial Times revealed plans by Treasury Secretary Scott Bessent to introduce universal tariffs, starting at 2.5% and potentially climbing to 20%. Trump fueled concerns further by advocating for even steeper tariffs and targeting key goods like steel, copper, and semiconductors.
Markets are increasingly concerned about the Treasury’s proactive approach, moving beyond mere rhetoric. This has embedded a new risk premium into dollar trades, which may persist. While equity futures hint at stabilization, the broader implications of tariffs—such as inflationary pressures and shifting Fed expectations—could provide long-term support for the dollar.
EUR: Tariff Risks Could Tighten Pressure on the Euro
As the ECB gears up for Thursday’s meeting, its anticipated 25bp rate cut and dovish tone may be overshadowed by rising tariff threats. The Treasury’s active plans to impose universal tariffs shrink the euro’s upside potential, leaving the EUR/USD vulnerable to further declines.
Our valuation model shows EUR/USD undervaluation widening from 1% to 1.8% since yesterday. If markets price in even greater tariff risks, we could see another 1%+ drop in EUR/USD, pushing it below 1.040. The euro remains without clear bullish drivers, particularly with the ECB expected to maintain its dovish stance.
GBP: Short Positioning Opens Recovery Opportunities
Investor sentiment on the British pound has turned negative, with net short positions reported for the first time since May 2024, according to the latest Commitment of Traders data. This shift reflects the pound’s weakening appeal, driven by poor economic data and concerns about rising government debt.
However, this cleanup of crowded long positions could lower the risk of further sharp declines. With positioning now more balanced, the pound may be better poised for recovery—particularly if sentiment shifts or economic conditions improve.
This week’s developments underscore the complex interplay of geopolitical risk, equity market shocks, and central bank narratives in driving FX markets. Stay alert for further tariff announcements and central bank signals as the situation evolves.