The European currency market today is characterized by dramatic volatility as the EUR/USD pair continues to retreat from multi-week highs in the vicinity of 1.1100. Speculators are shrewdly and hungrily dancing with the chaotic new market realities. Consequently, the EUR/USD has climbed by 0.66% ahead of the release of the Federal Reserve’s minutes later this evening. During all of these exciting developments, the editorial board of the Wall Street Journal has written a pretty darn amazing argument against international tariffs. They call on other countries to remove their tariffs as well. This recommendation comes from deep concerns about President Trump’s proposed “reciprocal” tariffs. If other countries respond in-kind with other discriminatory measures, then these tariffs would have to be removed too.
During Wednesday’s European trading session, the EUR/USD is likely to be the first major currency pair to test the 1.1000 psychological level. The recovery of the US Dollar is drawing cautious traders, particularly as escalating trade tensions raise anxieties regarding the US economic outlook. These conditions have led the European Central Bank (ECB) to update its previous projections of growth. They’re thinking anew about how today’s trade policies contribute to or impede inclusive economic growth.
ECB Revises Growth Estimates
The ECB’s first estimate was that the enduring trade war would land a 50 bps hit to growth. This will be felt beginning in the first full year after the law’s passage. Recent news has indicated that this estimate is an unrealistic one. One person with first-hand experience of the administration’s thinking told us the potential growth impact would be enormous. In fact, it could be more than 100 basis points during the first year.
“Initial ECB estimate of 50 bps hit to growth in first year under revision.” – Source with knowledge of ECB’s thinking
This update is particularly timely given the fast changing economic landscape. The ECB has been right to watch these developments, especially as they relate to real GDP growth rates. Importantly, GDP figures are only truly reliable in comparison to the prior quarter or the same time last year. Annualized quarterly GDP figures extrapolate the growth rate of one quarter as if it were stable for the remainder of the year. As a result, temporary shocks have the ability to completely upend growth trajectories in only a single quarter. These disruptions shouldn’t have a longterm dent for the full year.
Trade Tensions Impacting Market Dynamics
The increased US-China trade tensions have not just impacted currency values as mentioned above, it has added to the considerable market uncertainties. Active profit-taking has seen traders repositioning themselves ahead of the Fed Minutes release today. They’re skittish, worried that churning trade battles might exacerbate the very real economic anxieties that have taken root in American society.
The Wall Street Journal editorial board would be deeply thrilled by zero tariffs. This position strikes the right tone with markets and opens up a hopeful avenue for trade relations abroad. The board recommends that eliminating tariffs would create a more predictable trading climate, thereby spurring development and prosperity among all countries.
“A country’s Gross Domestic Product (GDP) measures the rate of growth of its economy over a given period of time, usually a quarter.” – Economic Analyst
As countries grapple with these recommendations, the stakes for currency markets in the outcome are high. The real euro-dollar relationship will be set by how domestic economic comparisons play out. International trade negotiations will be a huge factor in this evolving dynamic.
Implications for Economic Recovery
The critical challenges the Eurozone faces as it tries ever more desperately to stabilize its economy in this shifting, unstable, hyper-changing, economic environment. The ECB’s need to revise its growth projections highlights the critical need for policymakers to stay in close touch with changing economic conditions and adapt policies as necessary.
Negative temporary shocks to long-run growth potential can come from all sorts of things. Geopolitical shocks and global health crises, such as the onset of COVID-19 in early 2020, have brought this reality into sharp focus. These events are a stark reminder of how fast the economic landscape can change. Yet at the same time, they point to the need for greater flexibility for central banks.