Capital spillover from North America to Europe amid a potential increase in EU defense spending allowed the EURUSD pair to survive US tariffs against Mexico and Canada. Let’s discuss this topic and make a trading plan.
The article covers the following subjects:
Major Takeaways
- The US has imposed 25% tariffs against Mexico and Canada.
- The US economy is on the verge of stagflation.
- The euro is growing due to the capital spillover from the US to Europe.
- Long trades on the EURUSD pair formed at 1.042 can be kept open.
Weekly Euro Fundamental Forecast
President Donald Trump’s recent decision to impose 25% tariffs on goods from Mexico and Canada has sparked a significant trade dispute with these countries, which some have dubbed a trade war. According to the White House, there is currently no room for negotiation. Instead, they have called for the construction of automobiles and other factories within the United States, exempting them from duties. However, the EURUSD rate has continued to rise, driven by capital flight from North America to Europe.
According to Goldman Sachs, tariffs against neighbors and China will accelerate consumer prices in the US by 0.6 and 0.1 percentage points, respectively. This will force the Fed to keep the federal funds rate elevated for a long time or even raise it, which is good news for the US dollar. Unless, of course, the Fed starts saving the crippling economy amid the looming threat of stagflation. Indicators such as the purchasing managers’ index (PMI) in the manufacturing sector, along with its components, are pointing to approaching stagflation.
US Manufacturing Statistics
Source: Bloomberg.
Goldman Sachs does not rule out the possibility that the tariffs will be canceled or the postponement extended at the last minute or sometime after the introduction of duties. The FX market also seems to be anticipating this possibility, as evidenced by the reaction of the EURUSD exchange rate. Meanwhile, increased demand for European assets is leading to capital spillover from the US to Europe, providing a boost to the euro.
For the third consecutive month, European stock indices have outperformed their American counterparts. The latter appear to be overvalued, and the intensifying competition in the field of AI technologies has diminished the potential for a mutually beneficial investment strategy focused on the Magnificent Seven. Europe, on the other hand, is following a similar trajectory as Russia. Despite the expectation that sanctions would severely hurt the economy of a major oil producer, Russia has managed to accelerate its growth, largely driven by its military industry.
S&P 500 and Stoxx 600 Europe Performance Spread
Source: Bloomberg.
Expectations of increased defense spending are driving European bond yields higher, led by German bunds. Conversely, Treasury debt rates are falling due to fears of stagflation. The narrowing differential between US and German bond yields creates a solid foundation for the EURUSD rally.
In my view, European optimism is off the charts. Donald Trump has declared a trade war against Mexico, Canada, and China. Against this backdrop, he can target the EU as well. Tariffs imposed on the European Union could potentially hinder the region’s fragile economic recovery and prompt investors to reallocate capital away from European equities.
Weekly EURUSD Trading Plan
The EURUSD pair’s rally will likely be short-lived. Should the pair fall below 1.044, long trades formed at 1.042 should be reconsidered. In such a scenario, short trades can be initiated. As for now, long positions can be kept open.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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