March 06, 2025

“Divergence in the fortunes of the US dollar and the euro has led to a significant surge in FX volatility this week. Today’s ECB decision and tomorrow’s US payrolls data will be key in determining whether the euro rally can extend from here.”

Sam Cornford – Head of Trading

USD

There is a monumental shift happening in FX this week. EUR/USD is up over 4% – the second biggest weekly gain of the last 15 years – amid a wider rally in European FX driven by the unique combination of an historic surge in yields across the EU and a crumbling belief in the US economic exceptionalism narrative. USD/SEK needs a mention, too – the pair has fallen 10% in less than two months. Remember that the notion of US exceptionalism was as much about European leaders sleepwalking into a productivity crisis as it was about solid US economic growth. And the reason why we are seeing such big moves is because both pillars are being unravelled at once. Policy uncertainty paralysis, the end of Biden-era fiscal stimulus, and the onset of trade wars are damaging investor preference for the US just as Europe is waking up to what is required to defend itself and to pull itself out of stagnation. Only a month ago, Germany calling on the EU to relax deficit rules and start borrowing still seemed unimaginable – now it is reality.

Another headline helping European FX overnight was Trump’s decision to delay tariffs on cars for a month. The chop and change is making it difficult for investors to take it seriously that the 25% duties will persist. No big data releases today, so the focus is on non-farm payrolls tomorrow.

GBP

The pound has not quite kept up with the rally in EUR/USD this week, but a 2.5% gain has been enough to push GBP/USD through 1.29 for the first time since early November. The UK cannot afford to do anything like the fiscal spending splurge that Germany has planned, with Reeves likely to slash the welfare state at the March budget event, but it is being dragged up by the boom in European optimism and the creeping pessimism around the US economy. GBP/EUR is down around 1.4% over the past three sessions. Yesterday’s BoE hearings only re-emphasised policymaker anxiety around the economic uncertainty rather than giving us anything new, and in any case the focus is squarely on external developments.

EUR

The interesting thing about the spending-related surge in German bund yields is that US Treasuries have held steady. These tend to move loosely in tandem, and any divergences feed through relatively steadily into the yield differential and therefore EUR/USD. When this correlation breaks down, that is when FX volatility can increase significantly. Today, the ECB makes its final rate cut on autopilot, before policymakers are forced to begin considering their decisions much more carefully. A 25bps rate cut is priced at 98% and should take the deposit rate down from 2.75% to 2.50%, which is well within the estimated ranges for the ‘neutral’ interest rate (i.e. the one that neither constrains nor boosts the economy). It might be a single word that really drives the bulk of the move: ‘restrictive’. Rates were still considered to be restrictive at the last meeting, but this assessment might be dropped this afternoon. That would suggest that we might be closer to the end of the cutting cycle than the market expects.

Markets

Equities rebounded strongly yesterday as Trump delayed the Canada/Mexico auto tariffs for a month, in another display of the transitory nature of any tariff decision. The S&P 500 rallied more than 1%, and in Europe the German spending plans continued to drive the DAX higher with a 3.4% gain. Its total year-to-date gain is now 17%.

Main Economic Events (All Times CET)

8:00am: Swedish CPIF Inflation
2:15pm: ECB Policy Decision
2:30pm: US Jobless Claims

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