Trade Tensions Roil Currency Markets

Trump's push into a trade war has roiled currency markets, making it challenging to predict future developments with confidence.

Dollar 'Safety' Under Question

Forex is arguably the market most impacted by tariffs, as levies have a direct impact on the pricing of internationally traded goods, which in turn change the balance between supply and demand. As such, it does not come as a surprise to see that the US dollar weakened in the wake of the latest tariff announcements, as fears of a potential recession forced investors to pull out of the stock market and seek safety in US Treasuries. This is a complete reversal from the immediate aftermath of the election, when markets jumped on expectations that Trump's tariff policies would strengthen the dollar.

However, this situation has been disrupted, as the dollar is the go-to safe-haven asset. Investors face a dilemma when the risk they seek to mitigate comes from the US. In such an environment, alternative safe havens like the Swiss franc and the Japanese yen have leapt to the fore, despite recent doubts about whether the BOJ will hike rates and the SNB's recent easing. But with tariffs expected to increase inflation in the US and yields declining, investors have sought alternative stores of value. The euro initially benefited from this trend, as investors piled into increased government spending in the shared economy. However, recent tariff-driven highs have subsided as investors grow uncertain about Europe's growth prospects if the bloc opts for retaliation against tariffs rather than negotiating lower levies.

FX Pairs Hinge on Tariff Response

In a concerning sign of potential liquidity constraints, US Treasuries fluctuated by the largest margin in over two decades, as the stock market decline forced traders to sell bonds to cover losses, outweighing the temporary shift towards safe havens that had briefly pushed the benchmark 10-year Treasury yield below 4%. After a couple of days of uncertainty, markets have largely reverted to predicting two rate cuts from the Fed this year. While this has provided some support for the dollar, other currencies have not been as fortunate.

As reactions to Trump's tariffs play out, numerous countries have chosen to either lower tariffs preemptively (such as Vietnam and Israel) or try to negotiate before retaliation. This has left China relatively isolated in its immediate retaliation and vow to "fight to the end" on the trade front, although the EU's top representative has already been in contact with Beijing to coordinate a response should cross-Atlantic negotiations fail. Recently announced tariffs on Chinese goods of over 100% have raised concerns among countries reliant on exports to the world's largest economy, such as Australia and New Zealand, with both antipodean currencies declining in the wake of the tariffs. As most central bankers continue to point out, there is a high degree of tariff-induced uncertainty, so whether a recovery can be achieved will likely depend on how the tariff situation evolves in the coming days.

EURUSD Flag Left Behind

In a concerning development for the US dollar, the EURUSD has found support at 1.09 after completing a bullish flag pattern at 1.073 and breaking past its peak of 1.0957, opening the door to a test of the 1.1146 regional top. A sustained break above 1.12 would expose the 1.13 handle and beyond, while a failure to preserve the 1.09 support would bring into focus deeper corrections towards 1.073 or even a full-blown reversal.

Source: SpreadEx / EURUSD

Key Takeaways

The tariff situation has disrupted currency markets, with the EURUSD initially benefitting before losing some steam to find local support due to increasing chances of expected Fed rate cuts. However, China's retaliation and the potential for further escalation have raised concerns among economies that heavily rely on exports, with currencies declining against the greenback hinging on how the tariff situation evolves in the following days.