All change in the FX market as US exceptionalism is challenged?
The desk argues that the recent policy shift in Germany is reshaping the FX landscape, particularly challenging the notion of US exceptionalism. Per the full note from MUFG EMEA, the USD's failure to gain traction in response to President Trump's tariffs highlights a broader shift in market dynamics. This sentiment is underscored by the lack of significant economic data releases that could spur volatility in the near term. As traders navigate this evolving environment, the consensus view remains cautious, with no high-impact events on the horizon to catalyze movement.
What the desk is arguing
MUFG is positing that US exceptionalism is being challenged, particularly as the USD has not gained traction despite recent tariff announcements. This could suggest that market participants are reassessing the fundamental strength of the USD amid changing global economic dynamics.
The central argument revolves around the perceived impact of German policy shifts that could influence investor confidence. If the USD was expected to strengthen consistently with expansionary trade policies, its stagnation could signal deeper vulnerabilities not only in US economic policy but also in its relative attractiveness compared to other currencies like the Euro.
Where it sits in our coverage
Currently, our consensus target for EUR/USD stands at 1.075, with a firm spread that reflects cautious optimism against ongoing geopolitical uncertainties. This forecast aligns modestly with MUFG's commentary, suggesting a nuanced view of USD strength amid global shifts.
Specific banks have set varied targets reflecting their outlooks:
- Barclays: 1.08 for Q1 2026
- JPMorgan: 1.10 for Q1 2026
- Goldman Sachs: 1.09 for Q1 2026
How other firms see it
While MUFG highlights the potential challenges facing the USD, the outlook from other firms varies widely. For instance, Goldman Sachs shares a more cautious approach, echoing some of MUFG's concerns about US policy but remaining more bullish on the USD in the short term.
Conversely, firms like BofA are taking a more bearish stance against the USD, suggesting that as uncertainties mount, the currency could weaken further as global investors seek safer havens such as the Euro.
- BofA: Maintaining a target of 1.04 for next quarter
- RBS: Expressing skepticism toward USD resilience amid trade tensions.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01USD's inability to strengthen amid tariff announcements signals market reassessment.
- 02Significant policy changes in Germany could be influencing the USD.
- 03US exceptionalism potentially waning in the face of global dynamics.
Market implications
If USD weakness persists, it may induce broader shifts in portfolio allocations and encourage a flight to perceived safer currencies, thus reshaping market dynamics. Traders might begin to recalibrate their expectations regarding USD valuation, which could fuel volatility in currency pairs involving the Euro.
Risks to this view
The major risk lies in unexpected geopolitical developments that could impact core economic indicators for the US, such as inflation or the Federal Reserve's policy decisions. Additionally, further tariff escalations could trigger retaliatory measures from trade partners, exacerbating USD vulnerabilities.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday, the 7th of March, 2025. And joining me to pose some questions on the financial market themes for the week ahead is Hisham Hussain, Vice President, Institutional Investors, FX Sales, EMEA.
The following podcast is intended for professional investors and eligible counterparties only, and not for retail clients. Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Hello, Lee.
Welcome to you and the listeners. Good to speak to you again. Yeah, nice to speak to you again.
And I think we should just crack on. Lots happened this week. It has been a big week in financial markets.
German bunds have suffered their worst selloff since the 1990s, and the USD has continued to weaken sharply despite President Trump putting in place tariffs against Canada, China, Mexico. I'm curious to know, what are your thoughts on the latest developments? Yeah, like you say, it's been a very big week for financial markets.
We've seen the euro and other European currencies surging higher against the dollar this week, lifting euro dollar back above the 108 level. And to us, we see kind of the key kind of driver behind that move for a stronger euro and stronger European currencies is kind of a more proving outlook for Europe's economy going forward. And really, the big kind of positive catalyst for this change in investor sentiment towards Europe has been the fiscal plans that were released earlier this week from the Chancellor-in-Waiting Merz over in Germany, who announced much bigger than expected plans for government spending over the next kind of five to 10 years.
There obviously were two or three kind of major components to those plans. The first one being to put in place a new fund to allow the government to spend up to 500 billion euros on infrastructure investment going forward. That's around 10% of GDP.
Then on top of that as well, he also be changing the debt break in Germany to allow basically more unlimited room to increase defense spending as well going forward. So estimates have been suggested that that could lead to around 500 billion euros, up to 1 trillion euros of additional defense spending over the next kind of five to 10 years. So when you put all of that together, you're talking about a pretty substantial package of spending from the German government, which I think is obviously a lot higher than most people had been even contemplating in the markets.
And I think as a whole, that potentially could lift German debt to GDP by over kind of 20 percentage points over that period. So this is kind of almost unprecedented outside of a major economic emergency. So understandably, given the scale of that package, obviously it still needs to be passed through Parliament, but the market reaction clearly highlights that the expectation is that this ultimately will be passed through the current Parliament.
But once that's in place, the market's going to be watching to see how long it takes for that spending to kind of feed through and lift growth in Europe. Speaking to our kind of European economists here, he thinks potentially this could lift GDP growth in Germany next year from around 1% up close to say 2%. So it would be a significant kind of upgrade to the growth outlook in Europe, and that's obviously been reflected in higher borrowing costs in Europe alongside obviously the higher debt levels as well.
And as we've seen, that improving growth outlook in Europe is coming at a time as well when markets are becoming more concerned about the prospect of a slowdown in growth in the US. We certainly have seen softer economic data releases recently from the US economy. And I think the other major decision this week from Trump to put in place tariffs on Canada and Mexico, obviously has scaled back some of those tariffs in recent days, but still a good chunk of those tariffs are still in place.
And that we think will be disruptive for growth in North America on top of obviously the heightened uncertainty that this has created. So there is obviously a higher risk now that the US economy will weaken at the start of this year. And that's certainly taking the shine off the kind of investment theme for kind of US exceptionalism that we've seen kind of dominating markets in recent years.
So to us, it does make sense that we have seen the dollar weakening against other major currencies, particularly those European currencies in the very near term. And this kind of theme can continue to run with Eurodollar trying to push up closer towards the 110 level. We would be kind of wary though, that this ultimately will start to kind of peter out.
And to us, there's still the kind of obvious risk of a correction lower for the euro as we go into early April when Trump will announce his plans, which could put in place bigger tariffs on the EU as well. Thanks, Lee. There's a lot to soak in and obviously keep an eye on quite a few things, lots of moving parts.
So switching gears, the Bank of Canada is scheduled to hold their latest policy meeting next week. What are you expecting from the BOC and the performance of the Canadian dollar? Yeah, I think certainly next week, we're expecting the Bank of Canada to deliver another 25 basis point rate cut.
That was kind of up in the air, so to speak, before we had those kind of tariff announcements earlier this week from Trump. If we look at some of the recent data from Canada, it actually had started to come in on the stronger side of expectations. We saw a good upward revision to growth expectations in the second half of last year, and it looks as well that growth got off to a stronger start at the start of this year in Canada as well.
But I think the Bank of Canada obviously will now kind of look through that stronger data to some extent and will put more focus on the downside risks to growth from those tariffs that have been put in place by Trump on Canada. And for that reason, we think that will put more pressure on the Bank of Canada to lower rates further, to support growth. Obviously, the longer those tariffs are in place on Canada, or if he escalates and puts higher tariffs in place again on Canada from April going forwards, then that would add to downside risks to growth in Canada and put more pressure on the Bank of Canada to cut rates more deeply.
So, I think those risks are obviously going to be in focus next week for the Bank of Canada. So, it does make sense for them to keep lowering rates and to keep the door open for further rate cuts if required. I still don't think at this point that they would want to completely rule out the possibility that they may have to do another kind of bigger 50 basis point cut at some point.
We did see the Canadian economy slowing more sharply in response to this trade disruption that's currently playing out, but we just think it's probably too soon or preemptive for the Bank of Canada to do that as soon as next week. And then I think in terms of the kind of how that kind of plays out for the Canadian dollar, I think we can kind of see this week that the Canadian dollar has been kind of underperforming more broadly. I mean, yes, it has strengthened modestly against the US dollar, but it's kind of been certainly one of the weaker performers alongside the dollar when you look at it compared to other G10 currencies or emerging market currencies.
And we think there's a good reason there for the Canadian dollar to continue to underperform in the near term. So, it's a risk. Could be that the Canadian dollar weakens even more sharply if we start to see weaker data coming through from Canada or the Bank of Canada surprises and delivers a more dovish message next week.
Thanks, Lee, for your insights. Let's see what the next week holds, the last couple of weeks have been eventful. So, all the best to you and the listeners, and we'll see you again soon.
Bye, Raoul. Thank you. Thank you for listening to this MUFG Global Markets podcast.
Rate, review and subscribe and contact your MUFG sales rep for more information. Come back next week for more insights from the Global Markets Research Team.
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