Trump's tariff measures were softer than initially expected, gradually easing market fears and providing some breathing room for the euro. However, downside risks persist as economic growth and political uncertainties continue to weigh on the Eurozone. Additionally, the market has yet to fully price in Trump’s tariffs, with investors awaiting confirmed details rather than relying solely on media headlines.

EUR: Downside risk still exist

The past week saw limited developments within the Eurozone, with the EUR’s trajectory now heavily reliant on external factors, particularly Trump’s upcoming inauguration. Trump has previously expressed a desire to impose a 10% tariff on Europe, though rumors of universal import duties or gradual monthly hikes of 2–5% remain unconfirmed or unapproved. Given that much EUR negativity has already been priced in, positioning is becoming “stretched,” increasing the risk of short squeezes. Any significant positive surprise, such as Trump’s claim that he could end the Russia-Ukraine war within 24 hours, would pose an upside risk for the EUR by potentially boosting domestic demand and aiding Eurozone recovery.

Domestically, monetary policy divergence remains a key driver of EUR softness, with trade-related uncertainties and tighter US policy further dampening sentiment. Political developments in France added nuance, as Prime Minister François Bayrou’s softer fiscal stance temporarily eased political risks. However, concerns about fiscal credibility and downward economic growth revisions continue to cap the euro’s broader upside.

Looking ahead, market attention will turn to Trump’s inauguration and the release of Eurozone preliminary PMI data. While any disappointment in Trump’s policy announcements, particularly regarding tariffs, could pose a short-term challenge to the bearish EUR outlook, this scenario appears unlikely. From a longer-term perspective, the EUR remains under pressure due to persistent political uncertainties across the Eurozone, diverging monetary policies, and weak economic growth.

EUR/USD 4H Chart

USD: Trump 2.0

The USD remains well-supported due to strong economic fundamentals, cautious Federal Reserve commentary on rate cuts, and anticipation surrounding Trump's inauguration. Markets are keenly focused on Trump’s clarity on key policies, including tariffs, tax cuts, and immigration reforms, all of which could significantly influence economic growth and inflation. While there were recent reports suggesting Trump aides considered universal import duties, Trump quickly denied them. Early discussions around tariffs indicate a potential gradual hike of 2–5% monthly, but no final decision has been approved. If Trump’s actual tariff policies fall short of market expectations, a significant USD sell-off may occur, as much of the USD’s strength is already reflected in its price.

Aside from political, December's CPI release has reinforced the Fed's gradual rate cut strategy, aligning with its commentary on easing inflation concerns. Softer inflation data eased fears of persistent price pressures, as core inflation slowed for the second consecutive month. This trend supports the Fed's plans for two additional rate cuts this year, with markets anticipating the next move in Q2. December's core inflation rose 0.23%, driven by modest gains in core goods (+0.05%) and services (+0.27%), while the Fed's preferred core services ex-housing measure was subdued at +0.21%. These figures, alongside a softer PPI report, suggest the core PCE deflator rose by only 0.19% m/m. Although lower yields briefly softened the USD, the currency's bullish momentum remains intact. Sustained employment growth and initial policy directions under Trump could delay early rate cuts, but current data highlights a slowing inflation trend that supports the Fed's cautious approach. It will likely take more than a single month of softer inflation to shift the market’s strong sentiment toward the USD.

Looking ahead, the market focus will shift to Trump's inauguration and US preliminary PMI data. Any disappointment in Trump's policies, particularly tariffs, could trigger a USD sell-off and renew expectations for an earlier Fed rate cut. Overall, while current USD strength reflects optimism, it remains vulnerable to political developments and economic data surprises.

Current market context

During yesterday's early Asian session, Trump provided further details on his tariff plans, announcing that a 10% tariff on China would take effect on February 1st. He also intensified his rhetoric against the European Union. However, ECB President Lagarde downplayed concerns over tariffs, offering the euro some relief. Additionally, Trump's tariff measures were softer than initially anticipated, gradually easing market fears.

Despite this, downside risks remain for the euro, as economic growth and political uncertainties continue to weigh on the Eurozone. Moreover, the market has yet to fully price in Trump’s tariffs, as investors await confirmed details rather than reacting solely to media headlines.

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