• Fresh tariff concerns last week gave the USD renewed support. US data, however, are dimming the near-term economic growth outlook. This combination poses headwinds for pro-growth currencies, in our view.
• A potential ceasefire in Ukraine, greater fiscal spending in Europe, and country-specific factors should continue to shape European currencies, but clarity on these drivers still remain scarce.
• We like to stay unhedged on long USD positions and look for long JPY opportunities in the crosses, while hedging CNY longs. In emerging markets, we focus on idiosyncratic drivers by being long TRY, and on select yield pickup opportunities, like in the ZAR.
Additional tariffs on China and impending tariff deadlines in early March and April may still create ripples in currency markets. Tariff risk premiums across financial markets remain rather modest, as investors view them more as a bargaining chip for deals. We caution against complacency and look for renewed pullbacks in the CAD, the MXN, EUR, or the CNY. But not everything is about tariffs. The prospect of a Russia- Ukraine ceasefire deal and the possibility of additional fiscal spending in the Eurozone provide euro support and upside risks, mainly for 2H.
From China, we expect incremental fiscal stimulus measures and additional monetary policy easing. Efforts to prevent the yuan from weakening should continue as well. Front- loading of Asian exports to the US is likely to reverse, adding to our cautious view on Asian currencies, excluding the yen. We believe the opportunities in Latam and EEMEA are tilted more to the latter until more tariff clarity emerges. The pace of Turkish lira depreciation remains slower than implied by forwards, and we look for volatility-selling opportunities in currencies such as the South African rand.
Last week was a reminder that tariffs should be front and center for every investor. However, as the end-game on tariffs is far from clear, here are some other factors investors should monitor, as they will shape currency markets in 2025.
We have seen progress toward a peace deal in Ukraine. In our base case a ceasefire should be reached over the course of this year. This would likely involve Ukraine losing some territory but gaining Western security guarantees and reconstruction commitments. Russia may negotiate sanction relief and a partial resumption of gas flows to Europe. Lower energy prices for Europe and improved terms of trade conditions would favor better economic growth and be EUR-supportive. As for greater fiscal spending, mainly on the defense side, we estimate that lifting the defense spending of 21 European countries to at least 3% of GDP would require additional government revenues of a combined EUR 230bn (compared with an additional EUR 75bn to reach the 2% level). This could aid overall growth prospects and would help the European Central Bank (ECB) to end its easing cycle at a deposit rate of 1.75-2.00%. sufficiently large compression that motivates more hedging of foreign currency exposure by Japanese investors. With mounting tariff risks in mind, the JPY looks appealing both over the short and longer term, especially in the crosses with the CHF, the EUR, or the CNY.
The Bank of Japan (BoJ) is the only major central bank we expect to hike rates in 2025, while the others are likely to keep easing. We would not be surprised if rates are raised to 1% this year. We expect a robust macroeconomic backdrop and Japanese inflation to stay uncomfortably high. Moves in JGB yields tend to be gradual. However, a combination of lower yields elsewhere should trigger a sufficiently large compression that motivates more hedging of foreign currency exposure by Japanese investors. With mounting tariff risks in mind, the JPY looks appealing both over the short and longer term, especially in the crosses with the CHF, the EUR, or the CNY.
In Europe, the easing cycle began last spring, with rates in the Eurozone, Switzerland, and Sweden since lowered on average by 2%. In all three economies, we are seeing the first green shoots of a recovery that’s at least partly a result of looser monetary conditions. Sweden has already come to the end of its easing cycle. For Switzerland and the Eurozone, we expect it to conclude in the next few months. The US, however, only lowered rates from 5.5% to 4.5% last year, and has since remained on hold. The large yield advantage of the US dollar against its European peers is one of the reasons for its strength in recent months. Nevertheles, we expect the Federal Reserve to resume cutting rates in the summer as inflation comes closer to its 2% target and the economy loses more steam. This inflection point, at which European central banks stop easing while the US starts up again, should help European currencies to gain ground against the USD from the summer onwards.
We think they underpin the view that the USD’s path in 2025 will be a story of two halves, strength in 1H and weakness in 2H. They also suggest opportunities in European currencies, such as being long the NOK or the GBP, while avoiding the CHF, despite the potential of near-term tariff support for the franc. Lastly, they warrant continued caution on Asian currencies such as the CNY. But country- specific factors can also be powerful enough to drive currencies such as the JPY or the TRY.
