Market Brief: Dollar Retreats as Economic Data Slows and Geopolitical Shifts Bolster the Euro

The dollar is down sharply against most of its major rivals this morning as bets on the ‘US exceptionalism’ trade are unwound and investors throw money at the euro area ahead of an expected rise in government spending on defence. Defying consensus forecasts, on a year-to-date basis, the most widely-quoted measure of the greenback’s value—the DXY “Dixie” dollar index—is now down 2.3 percent, while the euro is up 1 percent, and the Japanese yen is sitting on top of the major-currency leaderboard with a near-4-percent gain.

Stagflation worries are suddenly stalking the US economy and financial markets. Friday’s personal spending numbers showed consumer outlays falling at the fastest pace in four years, a raft of business and household confidence surveys have turned dramatically more pessimistic, and the Citigroup Economic Surprise Index—which measures the difference between consensus forecasts and realised economic data—is rapidly approaching last year’s lows. The S&P 500 is negative on a year-to-date basis, ten-year Treasury yields are holding near the 4.25-percent threshold after having hit 4.81 percent in early January, and market-implied inflation expectations are ratcheting higher as investors respond to price warnings from corporate leaders. Data out this week—particularly Friday’s non-farm payrolls report—could add to the drumbeat of disappointing news hammering sentiment levels.

The “bullwhip effects” we have been expecting are beginning to play out. Trade data also released on Friday showed the US goods trade deficit widening to record levels in January, with imports jumping by an astonishing 11.9 percent—the biggest monthly surge in data going back to the 1980’s—suggesting that businesses and consumers were trying to get ahead of potential tariff increases by making purchases early. This suggests that violent downstream changes in trade and inventory levels could distort data releases in the months to come, artificially boosting output calculations during some periods and weighing on them in others, while making it difficult to discern the fundamentals driving underlying economic growth.

Against this backdrop, it is difficult to imagine the Trump administration choosing to implement a drastic increase in taxes—but the weekend’s events suggest that more imagination may indeed be needed. On Saturday, the president signed an executive order authorising an investigation into whether imports of timber threaten America’s national security, taking a step that could lead to even higher tariffs on Canada—the biggest exporter of lumber and wood to the United States—increasing prices for homebuilders in already-stressed real estate markets. In an interview with Fox News on Sunday, Commerce Secretary Howard Lutnick said he would separate government spending from gross domestic product calculations—apparently unaware that this is already done in the quarterly releases, and threatening to diminish market confidence in the veracity of government data releases. And Trump later announced the creation of a "strategic crypto reserve" for the United States that would presumably involve using taxpayer money to buy highly-volatile and incredibly risky tokens.

Markets look dangerously complacent. Measures of expected currency market volatility—which tend to spike ahead of well-telegraphed risk events—are down sharply from their early-February peaks, possibly reflecting a generalised lack of interest in making bets on the administration’s whims, but suggesting that traders remain unconvinced of the administration’s commitment to imposing near-universal 25 percent tariffs on Canada and Mexico by tomorrow. We worry that this confidence could be shaken in the coming hours and days as game theory imperatives push the president toward imposing substantial increases in import taxes, even if the political calculus suggests that they won’t remain in place over the long term.

For hedgers, we would suggest following Nassim Nicholas Taleb’s dictum: “If you must panic, panic early”*. Businesses with significant Canadian dollar and Mexican peso exposures should consider the pain that might be inflicted by trying to “catch a falling knife” when a tariff announcement is made, and work to minimise any regret ahead of time, whether through the use of currency options that establish tail risk protection, or market orders that execute automatically after specific thresholds are breached.

The euro is entering the week on a stronger footing after Friday’s Oval Office clash between US President Trump and Ukrainian Prime Minister Volodymyr Zelensky delivered a symbolic knockout blow to the post-World War Two political order, and provided a compelling case for more military spending from European capitals. After saying "It is now of utmost importance to step up defence investment for a prolonged period of time,” and pledging to help turn “Ukraine into a steel porcupine—one that potential invaders cannot digest,” European Commission president Ursula von der Leyen is expected to present a plan involving the mobilisation of pooled financial resources, an expansion of the European Investment Bank’s mandate, and a relaxation of fiscal rules to allow more defence spending in the coming days. Incoming German chancellor Friedrich Merz is also working to boost investment in the military by several hundred billion euro, and French president Emmanuel Macron is pledging to increase defence expenditures to more than 3.5 percent of gross domestic product, with heavier borrowing expectations helping to put upward pressure on European yields and narrow the cross-Atlantic rate differential that has kept the euro under pressure for years.

*Author of 'Fooled by Randomness', 'The Black Swan', 'Antifragile' and 'Skin in the Game'.

Please note: The morning Market Brief will be on hiatus between March 10 and March 21 as I take a badly-timed vacation. Try not to do anything that might trigger currency volatility. Thank you for your cooperation : )

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