Foreign Exchange Commentary

Summary

• Canadian dollar falls ahead of BoC Governor Macklem's speech.
• Euro currency drops after Purchasing Managers Index (PMI) data; dollar down a third week.
• Japanese yen is the week’s big mover, strengthening to below 150 per dollar.
• Bank of Japan’s Ueda says it would buy bonds nimbly if yields rise too sharply.
• U.S. Treasury Secretary Bessent expressed concerns about China’s unfair policies.
• Treasuries gain as the 10-year yield breaks below the psychologically important 4.5% level to trade at 4.46% as of this writing.
• U.S. Flash Manufacturing Purchasing Managers Index (PMI) 51.6; estimate 51.4.  Composite PMI 50.4; estimate 52.7, Services PMI 49.7; estimate 53.
• U.K. pound sterling is firmer this week as British inflation reaches a 10-month high.
• Australian dollar touches two-high.
• Mexico's peso stabilizes in the 20.20 – 20.35 range this week.
• Swedish krona hits one-year high versus euro as the run continues.
• U.S. February Final University of Michigan Consumer Sentiment fell to 64.7; estimate 67.8.

Noteworthy

• Dollar Lower This Week; Japanese Yen Breaches 150
• Euro Could Rise if Germany’s Fiscal Policy Loosens

The euro currency could benefit if the German government, newly formed after Sunday’s federal election, delivers more expansionary fiscal policy, Commerzbank’s currency analyst Ulrich Leuchtmann says in a note.

Germany currently appears to be the “sick man of Europe” with weak growth that is dragging down the eurozone economy, he says.  “Many market participants may suspect that a more expansionary fiscal policy could reduce the problem.” 

This could have a moderately positive effect on the euro currency. While this would push government debt higher, it would only marginally change the assessment of the euro-area’s fiscal situation.

The euro is vulnerable as markets aren’t pricing in much risk of a stronger-than-expected result from the far-right Alternative for Germany (AfD) party in Germany’s federal election Sunday, ING’s Francesco Pesole says in a note. “Polls currently place the center-right CDU/CSU alliance in the lead at 30% followed by AfD at 20% and the Social Democratic Party at 15%,” he says.

While markets aren’t expecting a better result for the AfD, they could still find good value in selling the euro ahead of the election given the single currency’s recent gains, Pesole says. ING remains negative on the euro against the dollar. As of this writing, the euro currency is trading at just below $1.05.

Elsewhere, the U.K. pound sterling faces a hit as the Bank of England could cut interest rates more than markets expect, TD Securities strategists say in a note. Following a recent string of better-than-expected U.K. economic data, the strategists now expect the BOE to deliver its next rate cut in May instead of March.

However, they still predict 125 basis points of cuts this year, including this month’s 25bp move. The market is pricing in a further 50bp of cuts this year, according to LSEG.  Investor positioning in sterling remains optimistic, leaving it vulnerable to a further downward correction, the strategists say. Moreover, heightened uncertainty surrounding President Trump’s tariff plans could weigh on the risk-sensitive sterling versus the dollar.

The latest European purchasing managers’ surveys support the case for a weaker euro, Monex Europe analysts say in a note. Manufacturing activity on the continent remained in contraction in February while a sharp fall in the French services reading is notable, they say.

This left the euro-zone composite purchasing managers’ index unchanged at 50.2 and is indicative of stagnant private sector growth.  This is “hardly a positive” for the euro-zone. The data come ahead of German elections on Sunday and the prospect of U.S. tariffs, “both of which pose short-term downside risks.”  Monex says it still risks falling to parity against the dollar.

The U.S. dollar has fallen recently but it could bounce back strongly in the second quarter if President Trump follows through on threats for disruptive trade tariffs, MUFG’s Lee Hardman says in a note. The dollar on Thursday hit a 10-week low against a basket of currencies as investors shrugged off tariff threats for now.

However, Hardman says the next couple of months should be pivotal for the dollar.  The various tariffs that Trump has announced are planned to take effect in either March or April, he says. “We still believe it is premature to drop our forecasts for a stronger U.S. dollar.”  The DXY dollar index rose 0.3% to 106.69, having fallen to a low of 106.33 on Thursday.

As summarized above through the lens of various currency analysts, there is a wide range of divergent views on the direction of the U.S. dollar which are complicated by the ever-evolving tariff situation. At the same time, interest rates seem to be declining in much of the world following the U.S. Federal Reserve’s lead that is not the case in select countries. A good example is Japan, where fears of potential Bank of Japan interest rate hikes drove the Japanese yen below 150 this week from the 156 level earlier this month.

In contrast, Europe’s economic stagnation persists, latest business surveys say.

The euro-zone economy continued to flatline in February, torn between signs of revival in Germany and a sharp decline in France, according to business surveys released Friday.

The euro area’s composite purchasing managers’ index – which gauges activity among manufacturing and services companies in Europe’s largest economy - held at 50.2, the same as in January, a survey compiled by Hamburg Commercial Bank and S&P Global said Friday. That was a little weaker than economists’ expectations of 50.5, from a poll by The Wall Street Journal.

Coming in just above the 50 no-change mark, the survey indicates activity expanded this month, if only slightly.

Germany, Europe’s largest economy, had its second straight year of contraction in 2024, but is showing signs of recovery in the early part of this year, ahead of a national election on Sunday. Investor confidence ticked higher this month in the hopes that the new government might be more capable of policy action to solve the country’s economic slowdown, after the incumbent coalition fell apart over disagreements on fiscal policy.

However, in Germany’s neighbor, France, activity sank to a 17-month low, according to the Purchasing Managers Index (PMI) data. The setback of the economy comes as a potential surprise given the recent easing of political uncertainty after Prime Minister Francois Bayrou passed a 2025 budget.

“There is certainly hope for a German government that will be able to act after the elections, which should also provide a positive impetus for the eurozone as a whole,” Cyrus de la Rubia, chief economist at Hamburg Commercial Bank, said.

However, that is offset by instability in France, and a U.S. trade policy that is spreading uncertainty, he added.

President Trump has said he will definitely apply tariffs on European Union imports, adding that value-added taxes levied by European governments also affect trade in ways that disadvantage the U.S., and should be accounted for in future decisions on duties.

Retaliatory tariffs are likely, too, with steel-import tariffs due to be imposed in March set to meet a “firm and proportionate” response, European Commission President Ursula von der Leyen said.

The PMI survey’s measure for manufacturing trails the services sector, a likely result of continued geopolitical and trade uncertainty, while also factoring in a persistent recession in the sector. High energy costs and competition from China have meant industrial production is around 10% lower than its pre-pandemic level.

Auto-parts maker Continental this week joined the list of industrial firms shedding jobs this week, saying it would cut around 3,000 positions, including in its home base of Germany.

Meanwhile, the survey said price pressures continued to be high, particularly due to still elevated energy costs. It comes ahead of a European Central Bank meeting in early March when policymakers are expected to cut rates again.

“Even though the ECB seems convinced that inflation is under control, cost pressures do continue to creep up for businesses,” ING economist Bert Colijn flagged.

Activity in the U.K. also nearly flatlined, with private-sector employment falling the most since 2020.

The lack of growth alongside rising price pressures points to a stagflationary environment for the Bank of England, said Chris Williamson, chief business economist at S&P Global Market Intelligence. The bank slashed its growth forecasts for the year at its meeting earlier this month.

However, Europe’s stagnation contrasts with signs of an acceleration in growth elsewhere. Similar surveys of businesses pointed to a pickup in activity in India, Japan, and Australia during the first weeks of February.