The last four weeks have delivered more uncertainty and volatility as expected and yet there were still a lot of surprises. Particularly surprising is the retreat of the USD amid rising risk aversion. Is this the end of US exceptionalism and USD supremacy? Perhaps, but uncertainty remains too high to take strong po- sitions. The safest bet in our view remains long JPY.
The USD continued to decline over the last four weeks. The USD DXY is down 3.2% since the start of the year and 4.6% since the peak on January 13th. USD weak- ness has been broad-based but not equal. The best performer has been the SEK (+7.9% YTD) followed by the JPY (+5.5% YTD). The CAD has been the weakest among the major currencies (-0.1% YTD), but still held up well given the tariff conflict with the US and the domestic political leadership turmoil. EM currencies have on balance also gained 3% YTD versus the USD, but with even more dispersion. Particularly notable is the resilience of the MXN (+1.8% YTD).
USD weakness is remarkable because it is happen- ing in times of increased uncertainty and risk aversion that typically favor the USD. The VIX has increased 6 points to 23 since the beginning of the year. Particu- larly surprising has been the divergence between risk assets and the USD at the start of this week. While new US tariffs against Canada, Mexico and China sent global equity markets into a tailspin, the USD DXY dropped 2.5% in two days. Is USD weakness amid in- creased uncertainty and risk aversion a sign that US exceptionalism and USD supremacy have come to an end?
It is too early to judge the impact of Trump’s policy agenda on the US economy, partly because the roll- out is still in full motion and likely to last a while. Nev- ertheless, there are some early indicators that the mar- ket interprets negatively. Most eye-catching is the swing of the Atlanta Fed real GDP now-cast for Q1 growth from +2.3% to -2.8% within the last seven days. There is always some truth in the data, but we caution to take this early growth estimate at face val- ue. The estimates are based on January data, when weather effects depressed consumption while tariff- front-loading boosted imports and the trade deficit. In our view, both effects are temporary. Moreover, we expect that rising imports will result in inventory ac- cumulation, which should partly offset the drag from trade.
More relevant than early Q1 growth estimates is probably the impact of the policy rollout on business and consumer sentiment. The data, which goes through February, shows clearly that both business and con- sumer sentiment have slipped since the start of the year (see Chart). The sentiment declines are not of magnitudes that typically herald recession but point at increased uncertainty. Especially consumers are worried that tariffs will result in higher inflation.
In our view, US exceptionalism stands on a strong foundation and has not been undone during the first six weeks of the Trump presidency, but the experience so far shows that there is downside risk. The softer data has prompted the market to lift Fed rate cut ex- pectations for the rest of the year from near zero to 75bps, which has been a key driver of recent USD weakness. In our opinion, however, elevated actual and expected inflation and firm labor market condi- tions will keep the Fed on hold for a while.
Recent USD weakness is not just driven by events in the US. Especially events in Europe have played an important role, which is also visible in the outperfor- mance of Euro-area equities. First, Euro-area econom- ic data, while still soft, has surprised to the upside. Second, market hopes for a cease fire in the Ukraine remain high despite the turmoil at the Trump- Selen- skyj meeting. Third, markets celebrate the prospect that Germany plans to soften the «debt brake» and engage in «all that it takes» military and infrastructure spending. In our view, these are all positive develop- ments but do not simply reverse the balance of pow- er between USD and EUR. A near-term cease fire in the Ukraine seems possible but the road to peace and security is probably long and difficult, especially if the US is reluctant to provide military support. And it re- mains to be seen whether the planned German spend- ing package will still be sufficiently potent after it has gathered two-third majorities in both houses of par- liament to offset the potential blow from US tariffs.
All in all, we think uncertainty will remain high for a while. In our view, pessimism over the US economy and Fed rate cut hopes as well as anticipation of a game-changing fiscal boost in Germany/Europe are overdone, while the risks of an extended tariff con- flict and geopolitical tensions are underestimated. Against this background, we are reluctant to take strong positions, but we remain long JPY, because we believe that Japan is more insulated from geopolitical and tariff conflicts while the BoJ is committed to con- tinue the process of monetary normalization.
