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Trump’s 50% tariff announcement on Brazil, a net importer from the US, appears linked to charges against former President Jair Bolsonaro, and is resulting in significant pressure on the BRL. But global risk sentiment and the US dollar remain only lightly touched. Expect news on a EU-US trade deal in the next couple of days, but the EUR/USD impact may be limited
USD: Could the Dollar Come Out Stronger Amid the Tariff Noise?
Trump’s letters to trading partners are so far primarily affecting local markets, rather than the broader market. Yesterday’s surprise 50% tariff announcement on Brazil has triggered a major BRL selloff. Here, a main issue is that the tariff appears related to charges against former President Jair Bolsonaro (that Trump believes are unfair), while the US holds a trade surplus with Brazil. The focus is now on whether any trade negotiations will include demands by the US related to Bolsonaro, which could prove a significant political hurdle and cause additional pressure on the BRL.
The dollar is slightly offered this morning, but remains largely a bystander amid tariff chaos. For now, we stick with our neutral near-term bias on the dollar. The question is what needs to happen for the dollar to take Trump’s tariff manoeuvres seriously. Our perception is that the bar is high for now, but should get lower as we approach the 1 August deadline. If by then trade negotiations with large US partners aren’t at an advanced stage, it will be harder to ignore the higher US tariff rate. The implications for the dollar aren’t as straightforward though.
We think the 10% average tariff rate is the bottom, and we could see it get to 20% from the current 14%. But how we get there matters hugely for the dollar. A gradual implementation of sector-specific tariffs should do much less damage to the dollar compared to sudden, ’Liberation Day’-style measures. The former may ultimately result in some inflationary effect that can keep the Fed cautious for longer – a dollar positive. June meeting minutes released yesterday confirmed that the cautious/hawkish front remains dominant in the FOMC, with only Waller and Bowman having explicitly moved to the dovish side.
Things can change a lot in the next three weeks, and our baseline call remains that the dollar will show significantly reduced interest in tariff noise. Data remains a bigger driver, and the potential FX impact of next week’s CPI figures still looks much bigger than trade news. Jobless claims will be in focus today. Initial claims have come in lower than expected in the previous two weeks, but the whole of June saw upward surprises in continuing claims – a measure of the difficulty to re-enter the workforce.
EUR: Volatility Declining Ahead of EU-US Deal
EUR/USD 1-week historical volatility is back below 7.0, confirming markets’ extra caution in dealing with Trump’s tariff announcements. By comparison, this peaked at 20 in April, and was above 9.0 only a couple of weeks ago. What is also worth noting is that the 1-month 25-delta EUR/USD risk reversals (the difference in price between calls and puts) have returned to zero. That had fallen to negative territory in June, but bounced back rapidly. Should this decline prove sustainable, it would signal markets are seriously scaling back bullish views on the pair – another testament of how the dollar is not bearing the risks associated with this round of tariff announcements for now.
A US-EU trade deal seems imminent, with reports suggesting the European Commission’s interim draft should include asymmetrical tariffs on EU products (likely the 10% base tariff), effectively choosing to de-escalation path. That is likely priced in by now, and barring major surprises in the details of the deal, EUR/USD may stay attached to the 1.170-1.175 area for now.
In the absence of relevant eurozone data, we’ll keep monitoring ECB speeches. Yesterday, Holtzmann reaffirmed his ultra-hawkish stance by saying rates should not be lowered any further, while the more moderate Nagel didn’t rule anything out. Today, we’ll hear from three dovish-leaning members: Cipollone, Escriva and Villeroy.
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