FX Markets in Holding Pattern as Trump’s Tariff Deadline Looms

The FX market has started on a caution phase, with traders closely watching a key self-imposed deadline from the Trump administration. The U.S. dollar, after rallying at the end of last week, has given back some gains, allowing EUR/USD to push above 1.0400. Market participants remain on edge as the White House weighs imposing hefty tariffs on Canada and Mexico—25% on imports from both countries—and an additional 10% hike on Chinese goods, on top of the 10% already implemented on February 4th.

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While there’s speculation that the administration might delay or scale back the tariffs, Treasury Secretary Bessent has suggested that, should they be enacted, the dollar could appreciate to offset around 40% of the impact. Given this scenario, analysts estimate a potential 5-10% depreciation in the Canadian dollar and Mexican peso. So far, the declines in both currencies have been moderate, signalling market hesitation over the likelihood of full tariff implementation.

Commerce Secretary Lutnick hinted over the weekend that negotiations remain fluid, with some potential for concessions toward Mexico and Canada. However, he warned that tariffs will take effect in some form on Tuesday. Canadian Prime Minister Trudeau, in response, reaffirmed that Canada is prepared to retaliate if necessary. Meanwhile, Mexico is reportedly exploring the possibility of imposing tariffs on Chinese imports as part of a broader negotiation strategy with the U.S.

China, however, is unlikely to escape further trade pressures. Another round of U.S. tariff hikes poses downside risks for the Chinese yuan, and policymakers may allow the renminbi to depreciate further as a countermeasure. A move toward 7.50 in USD/CNY could be in play, as China seeks to offset declining external demand.

Beyond the FX markets, these trade uncertainties appear to be weighing on U.S. economic growth. The Atlanta Fed’s latest GDP Now estimate for Q1 has taken a sharp downturn, dropping from +2.3% in mid-February to -1.5% by month-end. This downward revision is largely attributed to deteriorating net exports, as U.S. businesses frontloaded imports to beat potential tariff hikes. Additionally, consumer spending—a key driver of U.S. economic activity—has weakened, reinforcing concerns that trade disruptions could leave a lasting impact on growth.

Euro Outlook: German Fiscal Expansion & ECB Policy in Focus

The euro is finding support from renewed optimism over increased government spending in Germany. Reports from German media outlets suggest that centrist parties are in talks to establish two substantial fiscal funds—one for defence spending (potentially exceeding €200 billion) and another for public investment. While these initiatives still face political hurdles, if implemented, they could boost German economic growth and push government borrowing costs higher.

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Bond markets are already reacting to this fiscal shift, with the yield spread between U.S. and German 10-year government bonds narrowing to 1.8 percentage points, down from 2.3 points in December. The evolving geopolitical landscape, including recent tensions between the Trump administration and Ukrainian President Zelensky, is further strengthening the case for increased European defence spending.

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Traders are also keeping an eye on this week’s European Central Bank (ECB) policy meeting. The ECB is widely expected to proceed with a rate cut, but the key question is whether policymakers will hint at skipping another reduction in April. A more hawkish tone from the ECB could provide additional upside momentum for the euro, although any gains could be tempered by a more aggressive U.S. trade policy stance.

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