The US and the People’s Republic of China (PRC) have agreed a 90-day pause in the tariff escalation: US reciprocal tariffs on China are now reduced to 30% (from 145%) while Chinese tariffs on the US are cut to 10% (from 125%) – plus all legacy tariffs from Trump 1.0 and the Biden administration. Markets have celebrated this, with equities rallying strongly – with the US outperforming peers – bond yields rising and the dollar staging an impressive recovery.
I am highly skeptical on the sustainability of the dollar rebound: while I appreciate that short covering can run for a few more days/weeks, I still think the path of least resistance is for a weaker USD and a stronger euro.
For starters, this is a pause with no guarantee that the end game will be that benign. But even if this is the outturn, the US effective tariff rate will still be close to 15%, substantially higher than the 2.5% rate in the pre-Trump 2.0 administration. This is bound to generate stagflationary impact on the US economy, albeit to a lesser extend than feared in the aftermath of 2nd April.
Moreover, there is damage that has already been done. Indeed, the collapse in consumer sentiment indices and the sharpest rise on record in the US economic policy uncertainty index (April) are testament to a disrupted sentiment that may not be easy to fully reverse. This ought to mean a high-risk premium should be embedded in the price of the dollar.
Finally, there is the structural element at the other side of the Atlantic, namely the fiscal expansion at the German and EU level, with the former corresponding to the biggest change in fiscal mindset in post-war history. Back in 2020/21 when the taboo of common debt issuance was broken (NGEU) EURUSD appreciated from 1.08 to 1.23. The combined infrastructure and defense spending from Germany and the EU is now bigger in size and should be treated as a structural tailwind for the exchange rate: directly via increasing the demand side of the region (something that ECB’s Schnabel clearly highlighted as one of the reasons the central bank should maintain rates steady at current levels – implicitly pushing back against market pricing for a terminal rate close to 1.5%) and indirectly via the confidence channel. And all this will be happening at a time when euro area consumers have access to a nearly unprecedented level of precautionary saving, which can effective cushion any external or internal shock.
My bottom line is this: The dollar could appreciate further in the near term as the “sell US” mentality reverses and positioning gets cleaner. But there are broader structural USD headwinds, which includes strengthened fiscal policies in the Eurozone. I still think 1.15-1.20 is possible, though I acknowledge there is likely to be more two-way price action.
By Vasileios Gkionakis, Senior Economist and Strategist at Aviva Investors
