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Currencies, Markets

Dollar Catapults After the Announcement of Tariffs, The Euro Is Severely Punished

February 3, 2025 OnEquity

The US dollar surged on Monday, reaching a three-week high after US President Donald Trump followed through on his threat of additional trade tariffs, increasing demand for the safe-haven currency.

The dollar index, which tracks the behavior of the US dollar against a basket of six other currencies, was trading nearly 1% higher at 109.305 after reaching a three-week high.

Dollar Soars on Announcement of Tariffs

Over the weekend, President Trump announced, as promised last month, 25% import tariffs on both Canada and Mexico, along with a 10% tariff on China. He justified these measures as necessary to combat illegal immigration and drug trafficking.

All three affected countries vowed to retaliate, potentially signaling the start of a new global trade war. This has driven renewed demand for the US dollar as a safe haven.

The Chinese yuan fell to an all-time low against the dollar in the offshore market, with Chinese markets still closed for the Lunar New Year. Meanwhile, the Mexican peso dropped to its lowest level in nearly three years, and the Canadian dollar plummeted to levels last seen in 2003.

“It appears that the ‘maximum pressure’ strategy of this new Trump administration is to impose tariffs first, perhaps in an effort to negotiate the best possible deal quickly,” ING analysts said in a note. “The problem for investors, however, is that the outcome of these tariffs remains uncertain.”

“The reaction in the currency market has been, unsurprisingly, a defensive rally in the dollar. The DXY index rose by one percent. The most affected currencies were, as expected, commodity-linked currencies that benefit from global growth,” ING added.

Beyond its impact on global growth, tariffs could also contribute to inflation in the US economy. As a result, investors have slightly reduced their expectations for Federal Reserve rate cuts this year.

Last week, the Federal Reserve kept its benchmark interest rate unchanged in the range of 4.25%-4.50%. Officials also removed previous references indicating that inflation had “progressed” toward the Fed’s 2% target.

The Euro Is Hit Hard by Tariff Fears

In Europe, the EUR/USD pair fell 1.1% to 1.0248, with the euro dropping to its lowest level since November 2022 as investors braced for potential US tariffs on European goods.

In an interview with the BBC, Trump stated that similar tariffs on the European Union “will definitely happen,” calling the trade deficit with the EU “an atrocity.”

The United States recorded a nearly $200 billion trade deficit with the European Union last year.

“The growing prospect of a global trade war and the likelihood of tariffs targeting the EU is clearly negative for the euro,” ING added.

Providing slight support to the euro, data released on Monday indicated that the decline in Germany’s manufacturing sector eased in January.

Germany’s manufacturing purchasing managers’ index (PMI), compiled by S&P Global, rose to 45.0 in January from 42.5 in December, marking its highest reading since May of the previous year.

The final reading was nearly one point higher than the preliminary figure of 44.1, although it remains firmly below the 50-point threshold that separates growth from contraction.

The European Central Bank cut interest rates by a quarter of a percentage point last week—the fifth reduction of this kind since June—amid expectations that the largest inflation surge in decades is nearly over and that the struggling economy needs stimulus.

All eyes are now on the release of the eurozone’s flash CPI data later in the session, which is expected to show a 2.4% year-over-year increase in January, slightly above the ECB’s medium-term target of 2.0%.

The GBP/USD pair fell 0.1% to 1.2313, with the British pound relatively unaffected after Trump refrained from imposing tariffs on UK products in his BBC interview. However, he noted that the situation “can be resolved.”

“The pound sterling has been one of the least affected G10 currencies, possibly because the UK has a trade deficit with the US and goods exports account for a relatively small portion of GDP,” ING said.

The Bank of England is set to hold a monetary policy meeting later this week, where it may cut interest rates to stimulate the struggling economy.

Offshore Yuan Nears All-Time Low

In Asia, the USD/CNH pair rose 0.3% to 7.3400, with the offshore yuan touching record lows following the US’s announcement of a 10% import tariff on Chinese goods. This decision casts a shadow over China’s export-driven economy.

Beijing condemned Trump’s tariffs and threatened retaliation, while also preparing to introduce stimulus measures to mitigate the economic impact.

Private sector purchasing manager index data showed that Chinese business activity remained weak in January. The Caixin manufacturing PMI fell below forecasts for the month, though it managed to stay in expansion territory.

The USD/JPY pair rose 0.1% to 155.22, with the Japanese yen weakening to a lesser extent than other currencies due to the Bank of Japan’s hawkish stance and its status as a safe-haven asset.

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