Following the positive trade talks between the US and China last week, market sentiment toward the USD has improved, weakening the "sell America" narrative and prompting a shift in focus back to the dollar from the euro. At the same time, constructive US-UK trade discussions, along with the gradual normalization of UK-EU relations since Brexit, are also expected to provide near-term support for the GBP.

EUR: resilience to be tested?

Together with the CHF and its higher-beta Scandinavian proxies, the EUR remains one of the best performing G10 currencies so far this year. The FX investors remain optimistic on the currency as they expect the Eurozone to weather the global trade war storm well. In addition, given that the EUR should continue to benefit as European investors rebalance their portfolios away from the US and into Eurozone capital markets. However, many positives are already in the EUR price by now, making the currency vulnerable to a downside correction in the near term.

In particular, the most recent flow data on European stock-market ETFs would suggest that there have been some outflows following many months of record inflows. Thus, the recent EUR appreciation might add downside risks to the Eurozone growth and inflation outlook and thus force the ECB to adopt a more aggressively dovish stance from here. Moreover, markets continue to think that both EUR/USD and EUR/GBP are looking quite overvalued relative to fair value measures based on relative EUR-USD and EUR-GBP rate spreads respectively.

In the near term, the Eurozone data calendar is relatively light with only the German ZEW and the second Eurozone Q1 GDP print on the docket. In addition, will also hear from the ECB’s speakers. In the absence of significant data disappointments or dovish ECB speeches, EUR/USD could continue to follow the broad USD moves across the board

GBP: the best of both worlds?

As widely expected, the BoE delivered a 25bp rate cut last week. The MPC split three ways, however, with five policymakers including Governor Andrew Bailey voting to cut by 25bp, two voting to keep rates unchanged and two voting for a 50bp cut. The voting split highlights that any future policy decision would be finely balanced. This is further corroborated by the BoE’s forward guidance that pointed at “gradual and careful easing” from here.

UK rates investors saw the outcome of the meeting as a 'hawkish' cut and pared back their rate cut expectations for this year and next, in a boost to the GBP. It should be also mentioned that the BoE outlook for the economy could improve from here, given that the MPC has not pencilled in the impact from the trade deal between the US and UK that President Donald Trump and Prime Minister Keir Starmer announced jointly yesterday. EUR/GBP continues to trade at a premium relative to the EUR/GBP and should remain bearish on the cross from current levels.

The trade agreement between the US and the UK included lower US tariffs on steel, aluminium and cars, while keeping the baseline 10% tariff on other UK exports. The deal is nevertheless quite limited in scope and represents the first step towards a more comprehensive trade deal in the future. That being said, the UK moving closer to a trade deal would contrast with the still uncertain prospects for a deal between the EU and the US. Meanwhile, the gradual post-Brexit rapprochement between the UK and the EU continues and could, over time, alleviate some of the negative consequences for the former, in a boost to the GBP. All this should keep EUR/GBP under pressure, into near term.

Looking ahead, markets will scrutinise the GDP data for March as well as the employment data for March and April. In addition, markets will focus on a number of BoE speeches as they gauge the magnitude of the bank’s easing bias in the wake of the May policy meeting. Absent any significant data disappointments or dovish surprises, the still undervalued GBP could outperform the EUR.

EUR/GBP 4H

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