A blurry outlook

Back in my youth, I used to get what I now know are called floaters in my eyes. They were odd-looking, translucent squiggly lines, that hovered (or floated) across my vision and eventually disappeared. Having read various fiction series about teenage girls and boys with supernatural powers, I convinced myself I’d come across some kind of rune, hieroglyph, or other mark that would resemble a floater, which would somehow lead me to save the world from evil. By the age of eleven I’d downgraded that notion and thought they were maybe a foreshadow, and now, at twenty-six, I’ve come to terms with the fact that I’ve no psychic powers, ‘cause there’s none available, and that many people see those inconsequential squiggly lines.

Even though I have no supernatural foresight, I had my first ever eye test last week, and I’m incredibly fortunate to have healthy vision. However, that provides no help when trying to look through what is a very blurry economic outlook. With Donald Trump in the White House, realised volatility in FX markets has risen to 18-month highs, as the financial world attempts to navigate what feels like an enigmatic path for the next four years. In fact, just four days can be enigmatic enough, as the next big headline can land at any time. It used to be the case that I’d head home on Friday and switch off, so we can start over again on Monday. Yet my Sunday morning routine of coffee and TV now involves checking for any news on tariffs, or any other Trump comment that might shift the market dramatically. In EURUSD, the 1-2 February weekend saw the biggest move between Friday’s close and Monday’s open for nearly eight years, following Trump’s announcement of tariffs to be introduced on imports from Mexico and Canada, and threats of levies upon imported goods from the European Union (EU).

Ever since Trump’s election, tariff threats, announcements, and subsequent retaliations have meant there’s been a lot going on in the global trade space. But there’s a growing feeling that the US administration will use tariffs as more of a negotiation tool than anything else. Now, some may judge the president to be a relatively charmless man, but like him or not, when you put it all together those tariff announcements have proved relatively successful so far. Both Mexico and Canada made concessions on their respective borders with the US, causing Trump to postpone the activation of the announced tariffs. The risk is that a nation tries to call Trump’s bluff, and things escalate – a bit like US-Sino trade relations did in Trump’s first term.

Though it really, really, really could happen, the universal tariff looks off the cards for now, but the EU may not be so lucky. The EU’s major exports to the US include automotives and pharmaceuticals, two of the industries the US is looking to target – and there’s no physical border to use as a concession (there’s a great chunk of water between Europe and the US, soon to be renamed the American Ocean I’m sure!). Increasing purchases of US defence exports could be one thing Trump might accept as a compromise, but EU nations are already trying to ramp up defence spending to meet NATO commitments, so I’m not sure how much room for manoeuvre is available there. Trump says tariffs on the EU will “definitely happen”. The question then of course is, what does that mean for the euro?

Like has been said many times, Trump’s policies are expected to be inflationary, which would require higher US interest rates than otherwise and therefore likely boost the USD. That’s not to say there’s no other way for the USD though – that would be taking the fun out of everything. Trump’s pressure on the Federal Reserve to reduce interest rates, if successful, would likely put downward pressure on the USD and cause all sorts of fears over the central bank’s independence. Meanwhile, we’ve seen the president’s influence on the geopolitical front, and perhaps any conflict resolution could cause some improvement in risk sentiment and a weakening of the USD. But yes, the prevailing thought is USD strength, on higher prospective US inflation.

Effects on Eurozone inflation are less clear however – on balance, it looks as though they would be deflationary. Tariffs would reduce demand for US-bound EU exports, subsequently increasing the supply of goods available for the EU’s own consumption. Combine that with the potential for Chinese goods to be re-routed from the US to Europe as the next-best market, and those supply-side deflationary effects increase. Effects on Eurozone economic growth are almost unanimously negative meanwhile, worsening what is already a pretty troublesome economic backdrop. Hence, despite some commentary that this USD rally has no distance left to run, our economists’ forecast is for EURUSD to fall to parity shortly, and that it then settles down, stays around there before tentatively rising in H2.

Blurrier still perhaps is the sterling outlook. While the UK may be subject to some tariffs from the US, the bigger impact on the British economy may well be an indirect one via the global trade network.

Blurrier still perhaps is the sterling outlook. While the UK may be subject to some tariffs from the US, the bigger impact on the British economy may well be an indirect one via the global trade network. Meanwhile the health of the UK’s public finances remains in question, and the Bank of England’s ‘gradual’ approach to easing policy kicked 2025 off with its previously most hawkish policymaker doing a U-turn and voting for a 50 basis point (bp) reduction. Sterling liquidity has been hard to come by of late, with markets seemingly conscious of a relatively tender UK outlook that is shrouded in mist. Sterling-sellers find themselves waiting for that feeling to pass before any GBP strength can be meaningfully regained, which could still be a few months away. Looking further out, our economists forecast GBPUSD to reach 1.3000 by end-2026.

Understandably, it’s going to take time for this outlook to become any clearer. Speaking of which, the next edition of this newsletter is due in May, which will mark the end of a century of days for Trump’s second presidency. At that point we’ll know much more on the tariff front - whether it’s the global trade shake up that’s been touted or whether it’s nothing special - and on US policy more generally. We’ll have a much better idea of the 2025 interest rate outlook too, with the ECB and Bank of England likely to have cut rates again by then. Finally, on the UK front we’ll have had both the Spring Forecast and the local elections, and therefore likely a better gauge of British political sentiment, and maybe a rosier outlook for sterling. But wherever we are, I very much doubt we’ll have arrived there in a straight line.

Maybe those squiggly lines from my childhood were an omen to my future career at Investec, where I now stare at squiggly lines in FX for a living. Anyway, kudos to you if you spotted the Blur song title in each paragraph, even more so if you caught a corresponding lyric I’ve shoehorned in, and for complete overkill have a look at the first letter of each paragraph too. Just a bit of fun, and it gives me a sense of enormous well-being. Parklife.