Written by the Market Insights Team
Tariffs are effectively a tax on consumers, which is a headwind to growth by nature. Thus, in an already weakening US economic backdrop, bets of more Fed rate cuts are rising, which is weighing heavily on the US dollar. The dollar index is down over 4% year-to-date. Meanwhile, Germany’s multi-billion commitment to boost infrastructure and defence spending has sent the euro 4% higher this week against the dollar, to almost 4-month highs above $1.08. GBP/USD has also marched nearly 3% higher this week with eyes on November highs of $1.30, but both the euro and pound are now in overbought territory.
Tearing down the black zero and euro bears
Boris Kovacevic – Global Macro Strategist
This is what European investors have eagerly been waiting for. Germany’s likely next coalition of the CDU and SPD is preparing for a major fiscal expansion, potentially widening the deficit to 4% of GDP over the next decade. While details remain unclear and implementation risks are high, the plan aims to bolster military deterrence, drive economic recovery, and reshape Germany’s lagging infrastructure.
Around €500 billion could potentially be available for investment over the next ten years. How much of this will go into the expansion of the military complex is unclear. However, a report from the European Commission estimated that about €800 billion or 4.5% of the EU’s GDP could be mobilized in the coming years. To illustrate how significant the likely adjustment of the German black zero (rule of not increasing debt levels) is, we can take a look at their market impact. The 10-year government bond yield surged by an incredible 28 basis points to 2.8%. This is the largest single-day increase in financing costs since the reunification of East and West Germany in the 1990s.
It is also safe to say that no analyst saw the euro surging by 4% this week. However, we have consistently highlighted two key points over the past few weeks: first, that the dollar’s tariff-driven gains were likely to lose momentum as the US economy slowed, and second, that European pessimism had reached extreme levels—making positive surprises far more impactful on markets than any disappointing data or news. The German defense bazooka and signs that the Trump administration is monitoring the impact of tariff announcements on markets and the economy have pushed EUR/USD to the highest level this year above $1.08.
From now on, we warn on turning too optimistic too soon. First, the adjustment of the deficit rule needs a 2/3 majority in the German parliament which is still not guaranteed. Second, the global (US vs. RoW) tariff war has just started. Both can still act as headwinds for the euro. Still, the real rate differential makes it clear that levels such as $1.07 or $1.08 are not unjustified.
Dollar down 4% in 2025
Boris Kovacevic – Global Macro Strategist
Yesterday was probably the first trading session of the year in which global markets were not driven by developments in the US, but by the news flow coming out of Europe. The proposed increase of German defence spending and signs that the US economy are slowing have put the dollar on track for its worst week since November 2022.
The 3% drawdown is happening despite Trump’s rhetoric becoming more hawkish. This is likely due to two factors. First, investors are looking beyond the short-term safe haven flows and are asking what damage tariffs will do to the US economy. Second, despite this week’s tariff increases on Mexico, Canada, and China, potential exemptions and the undefined duration of the tariffs continue to confuse investors. Statements by the Trump administration have signalled that they are watching the impact of tariffs on markets and the economy. The White House excluded automakers from the newly imposed tariffs on Mexico and Canada for example. Could that mean that a large enough drop in equity prices or economic momentum could make Trump pivot?
Economic data came in mixed yesterday. The services sector beat forecasts and expanded modestly. Anxiety is high but the employment index rose from 52.3 to 53.9. This does contradict the ADP report, which showed that private hiring fell to the lowest level since July at 77,000. Against this ambiguous backdrop, all eyes will be on the nonfarm payrolls report tomorrow. The dollar needs an upside surprise on the jobs figure to stop the bleeding.
Pound now 7% higher than January low
George Vessey – Lead FX & Macro Strategist
As the US dollar dump continues, GBP/USD marches to fresh 4-month highs above the $1.29 handle. The pair has broken above key resistance levels including key moving averages like the closely watched 200-day and 200-week moving averages, which is a bullish signal. Moreover, in FX options markets, short-term risk reversals, favouring further sterling strength, have surged to their highest in around five years.
Expectations of the US dollar outperforming on escalating trade war tensions are fading as investors focus more on the negative repercussions on the US economy, with stagflation fears overwhelming. Instead of safe haven USD demand, traders are focused on a recent slowdown in US data, versus improvement in UK and European data, and the potential for relative outperformance between the economies. This is also having a positive impact on interest rate differentials between Europe and the UK versus the US, given the rise in Fed easing bets. Moreover, the spillover effect from surging German bund yields as a result of the proposed bazooka spending plan, saw the UK 10-year yield jump by the most in over a year yesterday, to over 1-month highs. This sent UK-US 10-year spreads soaring to an 18-month high, which has helped the pound’s rally against the battered and bruised US dollar.
But the near 7% climb from the low of $1.21 in January, and the 2.6% rally this week has pushed the pound into the overbought zone according to the 14-day relative strength index. A period of consolidation or a correction lower may be in the offing, but the psychological $1.30 level now serves as next resistance. Elsewhere, GBP/EUR has dropped 1.5% this week after enduring its biggest single day loss in five months as stronger flows into the euro dominate.
EUR/USD up 4% in last seven days
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: March 3-7
All times are in GMT
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.