Euro in Short-term Rebound Against Dollar, EU Prepares Tariff Insulation

The EC's Ursula von der Leyen is preparing counter-tariff measures. Photographer: Etienne Ansotte © European Union, 2020 Source: EC - Audiovisual Service.

The Euro is recovering against the U.S. Dollar amidst hopes the European Union's strategy to deal with Donald Trump will work.

The Euro to Dollar exchange rate (EURUSD) is clawing its way back into a short-term recovery sequence that could bring with it a test of 1.0418 before too long, although the unpredictability of U.S. President Donald Trump will act as a limiting factor.

The pair dropped to a low of 1.0209 on Monday amidst fears the U.S. would proceed with tariffs on Mexico and Canada, but the eventual agreement struck by the three nations confirmed President Donald Trump is open to negotiating away from the most market-unfriendly outcomes.

"The dollar remains soft due to the de-escalation in the trade wars," says Dr. Win Thin, Global Head of Markets Strategy at Brown Brothers Harriman. "With the one-month delay on Canada and Mexico tariffs in effect and the 10% tariffs on China in place, we are in a lull and markets are reacting as one might expect."

This offers the European Union some hope that it can do similar, removing severe downside tail risks for the Euro and helping it into a short-term rebound.

The daily chart shows the recovery from Monday's low takes EURUSD back above the descending trend line that defines the October-January selloff. Climbing above here is a first step taken towards stabilising the selloff and forming a firmer base from which to stage a more meaningful recovery.

1.0418 is the first target (the 23.6% Fibonacci retracement of the October-January selloff, ahead of a retest of the January high at 1.0532.

Above: EUR/USD at daily intervals.

Beyond the near term (in the coming days and 1-2 weeks), the bigger picture remains a challenging one for the Euro, and a move to parity remains a possibility.

"ECB pricing is far too hawkish. We have long argued that the secondary trade diversion effects of a trade war are the ones that concern us the most in Europe," says George Saravelos, FX strategist at Deutsche Bank. "An ECB repricing down to 1.50% (with the Fed unchanged) would take EUR/USD further down to 0.98-0.99 based on current betas."

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EU Readies Its Position Ahead of Tariffs

The extent of upcoming EUR weakness will depend on how deft the EU proves at watering down any tariffs Trump proposes.

"We think it’s only a matter of time before the EU and Japan come under threat. Until then, we view this correction in the dollar as a buying opportunity, as the fundamental drivers of dollar strength remain in place regardless of the tariff story," says Thin.

The European Commission is reportedly preparing an offer to improve bilateral relations with the U.S. that would include more liquefied natural gas imports, fertilisers and weapons.

This is an acknowledgement of the transactional approach Trump takes when considering tariffs and shows the bloc has listened to Trump's numerous demands that the EU should be buying more U.S. gas and oil.

It is reported that other areas for potential collaboration include closer alignment with the U.S. on Chinese export controls, investment screenings and working together to tackle China's overcapacity, particularly in the steel sector.

The EU has dealt with Trump before and it is believed the bloc will follow a similar strategy to that adopted in 2018.

Trump said at the weekend that the U.S. would definitely be imposing tariffs as the EU treated the U.S. "very badly" on trade.

The EU is readying a retaliatory package of counter-tariffs, but the details are being closely guarded. In 2018, the EU retaliated to Trump's tariffs by placing duties on companies such as Harley-Davidson motorcycles and Levi Strauss jeans.

In 2021 the EU and U.S. partly removed some tariffs temporarily, but this suspension is due to come to an end in March. The EU can extend that suspension past the March deadline if it thinks it can bolster its position with Trump.