While there are a huge number of cross currents and uncertainties right now for investors to deal with, including US tariff flip-flopping and EU ddefense upgrades, it seems to us that movements in the US dollar are most closely tied to the performance of the US economy. This is understandable given that US economic outperformance, or ‘exceptionalism’ as it has been termed, seems to have been behind the US dollar’s rise for some time.

Now the tide seems to have turned, at least temporarily, as more US data releases come through short of expectations. However, Steven Barrow, Head of Standard Bank G10 Strategy said it would be wrong to think that this alone can sustain significant weakness in the US dollar. For as data starts to underperform market expectations, so these expectations adjust to become more bearish and, eventually data releases will either fall into line with these (lowered) expectations or the data will start to beat forecasts. Either of these can stabilize or strengthen the US dollar.

The key to the longevity of any US dollar decline based on underperforming data is whether it provokes a policy response. The market has moved to price in three rate cuts from the Fed this year from the one that was priced into the futures market before the data started to deteriorate. However, the Standard Bank has not changed its expectations as it still sees one rate cut this year with this not happening until late in the year.

Talk of a US recession seems very premature even if we accept that consumer and business sentiment appears to have been unnerved somewhat by the noise around US government policy, particularly as it applies to tariffs. If we put all this together, it rather suggests that the speed and extent of the US dollar’s recent slide are not likely to be a template for what happens in coming weeks and months.

“Don’t get us wrong, we do see the US dollar sliding in the longer-term; but not at the sort of speed we have seen recently. If we think about this in terms of euro/US dollar, for instance, our sense here is that the euro has moved back into the 1.05-1.10 range that had existed for much of the two years prior to Trump’s election win last November. Ultimately, the decisive break in this range should be to the high side, but it may still take some time for this to happen”, said Steven Barrow.

One factor that could hold up the euro’s advance against the US dollar is US trade policy; particularly tariffs. What we have seen so far in the tariff story has been threats against Canada and Mexico that have subsequently been rescinded, and punitive tariffs placed on China.

In theory, tariffs should produce weakness in these currencies. The Canadian dollar and Mexican peso have fallen as might be expected but the scope for renminbi weakness is limited by the activities of the Peoples Bank of China. In comparison, the euro has been largely unaffected. But if we look ahead, it seems that the main thrust of US tariff policy will be reciprocal tariffs and not isolated tariffs, such as those on Mexico and Canada that relate to border security.

Therefore, the key will be looking at those countries that could attract steep reciprocal tariffs. On the surface, the euro zone is not one of these as tariff rates are similar to those in the US. However, should the US choose to deem the EU’s Value Added Tax (VAT) rate as a tax on US exporters to the euro zone, it could be a game-changer as this rate average around the 20% level.

In short, we could find that, in the end, tariffs on the EU come in at 20%, or more, while the likes of Canada and Mexico see tariffs go back to zero as befits the free-trade USMCA deal between the three countries, once the border issue has been sorted out. With the US pledging to address the reciprocal tariff issue from the start of April, we may find that euro bulls are best served by taking any profits at this point, rather than pushing for more.

This being said, Steven Barrow said none of this would deflect from the fact that the euro zones new-found fiscal vigour could aid the euro over the long haul, and particularly Germany’s Damascene conversion to significantly higher defence spending. It is not just that the euro has risen so far and so fast that a correction seems possible in the near term. The same is true for the yen as well with data on speculative positioning currently indicative of a market that is running very long on the yen.