Dollar Declines Amid Growth Concerns, Euro Strengthens on Increased Defense Spending

The US dollar fell on Tuesday, pressured by increased trade tensions and signs of economic slowdown, while the euro held firm despite the pause in US military aid to Ukraine.

At 04:30 ET (09:30 GMT), the dollar index, which measures the currency’s performance against a basket of six currencies, was down 0.5% to 106.160.

Growth Concerns Weigh on the Dollar

U.S. President Donald Trump announced Monday night that new 25% tariffs on goods from Mexico and Canada will take effect, along with a doubling of taxes on Chinese products to 20%. These measures, aligned with his campaign promises, pushed the Canadian dollar to a one-month low and the Mexican peso to its weakest level since February 3.

While tariffs typically strengthen the dollar, analysts now see these policies as mistimed in the current economic cycle. Recent data shows that U.S. consumer confidence has fallen to its lowest level in 15 months, fueling fears of an economic slowdown.

Additionally, the Atlanta Fed’s GDPNow model projects an annualized contraction of 2.8% for the current quarter—a sharp reversal from last week’s positive estimate of 2.3%.

“Washington is betting on protectionism too early in this administration and without sufficient domestic support,” ING analysts wrote in a report.

Market expectations for Federal Reserve rate cuts have also shifted. Traders now anticipate 75 basis points of easing rather than 50, reflecting concerns over slowing economic growth. This adjustment has prevented strong dollar buying, despite ongoing trade conflicts.

Speculation is also growing about a potential shift in U.S. trade policy, akin to the 1985 Plaza Accord, aimed at weakening the dollar to boost U.S. competitiveness in global trade.

Will the Euro Benefit from Increased Defense Spending?

EUR/USD rose 0.3% to 1.0520, rebounding from a two-and-a-half-week low, even after the U.S. suspended military aid to Ukraine following a dispute between Trump and Ukrainian President Volodymyr Zelenskiy.

While the suspension aims to pressure Zelenskiy into signing a strategic minerals agreement with the U.S., it could also drive significant increases in European defense spending, with notable implications for economic growth.

According to Reuters, Germany is considering creating new funds worth hundreds of billions of euros for defense and infrastructure investments. Deutsche Bank analysts describe this as a “paradigm shift” in Europe’s largest economy, estimating that these funds would represent about 20% of Germany’s GDP.

GBP/USD rose 0.2% to 1.2723, with the pound benefiting from the prospect of increased defense spending. U.K. Prime Minister Keir Starmer announced over the weekend a £1.6 billion missile deal for Ukraine and pledged to raise defense spending to 2.5% of national income by 2027, with a further increase to 3% in the next parliamentary term.

Yen Strengthens After Trump’s Criticism

In Asia, USD/JPY dropped 0.4% to 148.96, with the yen reaching a four-month high after Trump accused Japan and China of currency devaluation. His remarks could influence the timing of the Bank of Japan’s interest rate hike.

“Risk aversion favors the yen, and the threat of a global trade war could cause international interest rates to converge with Japan’s low levels, further supporting the Japanese currency,” said ING analysts.

USD/CNY fell 0.1% to 7.2749, as the yuan received support from the Chinese government. Beijing announced retaliatory measures against U.S. tariffs, targeting agricultural products. However, a full-scale trade war is unlikely to aid China’s struggling economy.