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Institutional Insights: Credit Agricole FX Weekly 28/02/25

The turnaround of the USD fortunes in the weeks following President Donald Trump’s inauguration on January 20 took many by surprise, partly due to the market's expectation that the initial phase of Trump 2.0 would unfold quite differently from Trump 1.0. Investors were caught off guard by two factors: (1) Trump’s tariffs are yet to be fully implemented, with the US President seemingly eager to utilize them as a bargaining chip rather than a means of increasing fiscal revenue; and (2) the US economy appears to be struggling under the strain of the Fed’s tightening policies and uncertainties stemming from Trump’s policies and global politics. The USD outlook has started to show signs of improvement this week in reaction to more tariff threats from President Trump. We believe that the currency is likely to recover further losses in the upcoming weeks, although it may find it challenging to maintain levels above its January peaks. Notably: (1) Trump’s trade conflict could escalate significantly on March 4 with the introduction of tariffs on Canada and Mexico, along with metal tariffs and reciprocal tariffs in the subsequent weeks, negatively impacting risk sentiment while bolstering the USD; and (2) the US rates market is now anticipating more than 50 basis points of Fed rate cuts in 2025, which suggests that we do not expect any further loss of USD rate advantages. In the short term, alongside tariff headlines, attention will be directed towards the Non-farm payrolls and ISM data for February, as well as comments from Fed officials. Considering that some Fed-related negatives have already been priced into the currency, it would require significant data disappointments to stoke expectations of Fed easing and negatively impact the USD. Furthermore, even if there is another possible delay of tariffs for Canada and Mexico next week, FX investors may remain cautious about the risks associated with the trade conflict, providing support to the USD. Elsewhere, Swedish inflation and Canadian employment data will also be closely monitored. Additionally, we anticipate that the ECB will reduce its rates by 25 basis points next week but will indicate that its policy stance is becoming less restrictive. This, combined with an adjustment in the bank’s inflation forecasts, could result in ECB President Christine Lagarde appearing more non-committal regarding future rate cuts. We continue to believe that market expectations surrounding the ECB are overly dovish. A ‘hawkish’ rate cut from the ECB next week, along with indications from Eurozone PMIs suggesting that the worst of the economic downturn is behind us while HICP inflation is only gradually moderating, could help mitigate the rate disadvantage faced by the EUR. EUR investors will also keep a close eye on the latest developments regarding EU tariffs and the situation in Ukraine.

EUR/USD: The EUR faces challenges from domestic economic struggles and global geopolitical risks. However, it appears oversold and undervalued. Economists expect no Eurozone recession and project an ECB terminal rate of 2.25%, above market expectations. Political stability post-German elections and potential de-escalation in Ukraine could ease risks, boosting Eurozone demand. EUR/USD may stay grounded in 3-6 months but recover cautiously in 6-12 months. USD: While the USD weakened post-Trump’s inauguration, it may regain ground as trade war risks escalate. However, positives are largely priced in, and we expect the USD to remain near recent highs into early 2025 but decline long-term due to Fed rate cuts, fiscal concerns, and a potential return of Trump’s “Weak USD Doctrine” by H2 2025. CHF: Safe-haven flows have bolstered the CHF amid Eurozone uncertainties. Once risks subside, the CHF could return as a funding currency, supported by near-zero rates and high valuations. The SNB will monitor FX developments amid Swiss disinflation. JPY: The JPY remains resilient, with the US-Japan rate spread narrowing as the Fed cuts rates and the BoJ hikes. This reduces USD/JPY carry appeal, with volatility likely to persist due to rate path uncertainties and Trump’s trade policies. Japan’s MoF may intervene to support the JPY. GBP: UK economic concerns and high borrowing costs could necessitate austerity, creating headwinds. However, political stability and economic outperformance relative to the Eurozone support GBP as a higher-yielding EUR proxy. GBP/EUR is constructive for 2025-2026, while GBP/USD may recover in 2026 after initial struggles. CAD: USD/CAD hit highs above 1.45 due to Trump’s tariffs, but risks remain tilted downward for CAD in early 2025 amid a wider BoC-Fed rate gap. Canada’s relative growth outperformance could aid a gradual CAD recovery. AUD/USD: Trump’s China tariffs and a falling rate differential weakened AUD/USD, but softer tariffs and less dovish RBA policy could provide support. NZD/USD: NZD/USD was pressured by China tariffs, a falling NZ-US rate differential, and dry weather. Lower-than-expected tariffs, stable rate differentials, La Niña, and NZ growth rebound should support NZD/USD.

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Publication date:

2025-02-28 12:25:54 (GMT)

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