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Following significant shifts in European bond yields, EUR/USD is trading around 1.08. Our calculations suggest the pair is slightly overvalued by 1.2%. It’s prudent to avoid predicting a top before the ECB meeting and US payroll data release.
US dollar sentiment remains weak. Unprecedented changes in European rates impacted FX markets. German yields jumped 30bp post-fiscal announcement, a 25-year high. While the euro’s implications are discussed later, the impact on the dollar is significant. The disconnect between US and German yields signals markets are reassessing US economic exceptionalism.
USMCA auto exemptions were granted, while Canada’s tariff response seems more aggressive than Mexico’s. Both currencies have strengthened slightly. Disappointing US data, such as the ADP print, weighs on sentiment despite a stronger-than-expected ISM services report.
Focus shifts to US payrolls. The January trade deficit may trigger stronger tariff reactions. While a dollar rebound shouldn’t be expected immediately, the recent sell-off might be excessive. Prolonged tariffs and their European impact suggest a future dollar recovery, but for now, DXY stabilization around 104-105 is likely.
Germany’s fiscal spending announcement spurred significant European market changes, leading to a bund selloff. Euro implications are substantial. The 1.08 EUR/USD level includes a contained risk premium. Rate differentials have tightened, with markets repricing the ECB curve higher and the Fed curve lower.
With major events ahead, predicting the EUR/USD peak is premature. The ECB’s rate cut is unlikely to be affected by recent market moves. The communication from the ECB will consider fiscal and market developments. While the ECB has largely been repriced, Lagarde could strengthen the euro further by signaling caution about further cuts. An extension to 1.10 in the rally would be inconsistent with the prospect of US tariffs on the EU and rate differentials.
