At the start of the year, virtually everyone expected the dollar to strengthen further. Trump’s policies were considered inflationary but, in aggregate, supportive of growth — the mantra is Make America Great Again, after all. On the other hand, Europe remained in the doldrums with Germany grappling with extremely weak growth and France in the midst of political turmoil. With the growth and interest differential in favour of the US, there appeared to be only one logical outcome — the greenback would stay strong. Yet, things did not unfold as expected. In the first quarter, the dollar fell by 4.5% against the euro. So, what went wrong?
Trump has engaged in a fierce trade war, ramping up tariffs on imported goods. Theoretically, when a country imposes tariffs on imports, the currency of the exporting country depreciates to offset the increase in the price paid for its products. However, markets have been caught off guard by the scale of these tariffs and are concerned about their potential impact on US growth. As a result, expectations have shifted towards the Fed cutting interest rates more than initially expected. At the same time, Germany has surprised the markets with the announcement of a massive fiscal stimulus plan on defence and infrastructure, prompting a slightly more hawkish tone from the ECB. The narrowing growth and interest rate differential dragged the dollar down, a move further exacerbated by the unwinding of long positions.
We believe the market has become overly pessimistic about the US economic outlook. Of course, much depends on where tariffs ultimately settle, but we don’t believe that Trump’s objective is to crush the economy — quite the opposite. Secondly, while Germany’s pivot towards fiscal expansion is a game-changer, the real impact is unlikely to materialise until next year. As growth expectations readjust, so too should the euro-dollar exchange rate. Nevertheless, all things considered, we are perhaps not quite as positive on the greenback as we were at the start of the year.
Date of report: March 31st 2025