Euro Gains as Trade Tariff Fears Recede

The euro is on track for its best weekly performance in over a year, driven by waning expectations of interest rate cuts and reduced concerns about imminent US trade tariffs.

The common currency has risen by more than 2% to $1.0509, marking its largest weekly gain since July 2023. The move is partly attributed to the weakening US dollar this week.

The euro's recovery follows a slump since September due to fears of Donald Trump targeting Europe with tariffs after his inauguration. However, the new US president has initially focused on Mexico and Canada, delaying penalties on Europe.

"Trump's delay in imposing tariffs against Europe and other trading partners has partially reversed the euro's bearish trend," said Roberto Cobo Garcia, head of G10 FX strategy at BBVA. "The euro's current valuation, technicals, positioning, and market pricing for the European Central Bank suggest that shorting the euro has been overdone."

A stronger-than-expected German PMI reading on Friday further boosted the euro, pushing the two-year German bund yield to a one-week high and prompting traders to pare back rate-cut bets. Markets now anticipate around 88 basis points of monetary easing from the European Central Bank this year, compared to 95 basis points on Thursday.

Concerns about trade restrictions exacerbating the eurozone's economic slowdown and necessitating deeper rate cuts had led hedge funds and speculators to pile up bets against the euro, reaching their highest level in about three years. A further unwinding of these bets could drive the euro towards $1.0630, a key resistance level, according to Cobo Garcia.

While some analysts believe the euro could trade closer to $1.06 without the threat of tariffs, options market activity suggests that this week's rebound is driven by a rebalancing of short euro positions rather than a fundamental shift in sentiment.

However, Insight Investment cautions against complacency, warning that the euro could fall "significantly lower" if Trump follows through on his threats to tax European imports. Ongoing concerns about the eurozone economy and market volatility could also limit the euro's near-term recovery.

"If long dollar positions unwind in the coming weeks and the euro moves towards $1.05, our bias would be to sell the euro rather than buy it," said Francesca Fornasari, head of currency solutions at Insight.