No zest for the wicked

This quarter’s ‘Thoughts of a trader’ was in grave danger of showcasing the madness of a trader, as I tried to shoehorn Donald Trump’s tariff policy into an analogy around lemonade stands and lemon trees in a fictional village. But I couldn’t quite figure out how inter-cul-de-sac exchange rates worked in entirely lemon-based economies, and I never really landed on the right punchline. When Trump gives you lemons… hedge your dollars? Clearly, it needs a lot of work.

What is also clear is that US policy instability has left a sour taste in investors’ mouths, and the subsequent dollar weakness raises several questions around reaction functions in FX markets. Those questions are largely unanswerable, for now, but it’s worth hypothesising about a few of them nonetheless.

First, will the USD continue to act as a safe haven currency? Well, funnily enough I wrote my dissertation on whether safe haven currency properties were dynamic or not, and they absolutely are. Sterling, for example, is more of a ‘risk-on’ currency now, having acted more like a safe haven before the global financial crisis. The dollar looks to have retained that status for now though, having benefited from a flight to safety following the escalation of the conflict in the Middle East. That said, the rally could also be attributed to a jump in the oil price - as the US is a net oil exporter - or a reduction in speculative positioning, given much of the market had sold dollars of late.

Second, how relevant are economic fundamentals right now, or is all the focus on tariffs and geopolitics? Those two factors have certainly driven the most dramatic moves of late, and for a time the USD retreated even as US Treasury yields rose and vice versa, which was unusual and a result of markets ascribing a lower value to US assets. But while we’re waiting to see the impact of the tariffs in the US, central banks and interest rate expectations are still a major driving force in the market. Most recently, GBPEUR has taken a leg lower as the ECB signalled more strongly than expected that its interest rate cutting cycle may have ended, while UK economic data has been weaker this month.

And third, what does sterling do when it is void of its own clear driver? There are lingering concerns about UK public finances, and the pound is moving in line with UK interest rate expectations, but we’re lacking a key story. Instead, sterling is feeling a gravitational pull higher from the EU’s proposed spending increases, while simultaneously being dragged around by risk sentiment courtesy of the US president and geopolitics, which arguably makes it even more tricky to anticipate.

Sometimes when trying to find answers all you uncover are further questions. But questioning and challenging the outlook is healthy, especially when the outlook is – much like my favourite lemonade – cloudy and in danger of bubbling over at any point. If you would like to continue this conversation or discuss ways to reduce uncertainty from FX exposure, do get in touch.
 

Performance vs the USD this year (%)

Quoted as XXXUSD for EUR, GBP, AUD and NZD, and USDXXX otherwise
As of 13:31 BST, 19th June 2025
Source: Bloomberg, Macrobond and Investec