Market headlines around US President Donald Trump’s massive tariff announcements have focused on the large drop in the stock market. But the effect on the currency markets has been just as profound. Traders are still trying to find their footing in the new economic situation. The hope was that the announcement would reduce uncertainty, but it appears to have actually heightened as US trade partners try to figure out what to do.
Trump announced the measures after the market closed on Wednesday, so the impact wasn’t felt fully until trading on Thursday. The near 5.0% drop in the US benchmark stock index was mirrored in other indices, and even around the world. It was the worst daily performance since the covid-induced market crash of early 2020. Markets opening on Friday suggest that the trend will continue, though it’s normal for there to be at least a short-term rebound after a selloff of that magnitude.
The Big Moves
Typically, the stock market and the currency move in opposite directions. But, not this time. Investors have become acutely concerned (though not full on panic, yet!) that the US is heading into a recession, or worse, stagflation. This has prompted a move to buy up Treasuries. The yield on the benchmark US bond dropped precipitously to 4.04% from 4.20% just a day earlier.
This drop in the rate of return that investors can get by buying dollars prompted a more than 2% drop in the dollar index in less than 24 hours. The EURUSD climbed above the 1.100 for the first time in months. If the situation persists, the dollar could continue to fall lower. Deutsche Bank has warned of the possibility of a crisis of confidence in the dollar that could upend currency markets. But, with the US economy still showing resilience, this is seen as a remote possibility for now.
What About the Fed?
This is where things are a little more complicated. The initial reaction from the market was to expect the Fed to move sooner, but that quickly faded. The odds of a rate cut at the next FOMC meeting were around 10% before the tariff announcement, but moved up to about 30% in the aftermath. Which means the market still expects the first rate cut of the year to happen in June.
The reason that there isn’t a bigger move here is that the tariffs are expected to push up inflation. This limits what the Fed can do to support the economy, and, by extension, the stock market and the dollar. As long as inflation remains above target, it will be hard for the FOMC to justify a rate cut even if the economy is underperforming.
What’s Next?
Analysts have said that the tariff announcements were “worse than expected”. That is, they were harsher on trade partners than had been anticipated. The Trump Administration seems satisfied with the progress so far, saying that the tariffs offer good negotiation leverage. Some, such as Germany’s Finance Minister Robert Habeck, argue that the White House will be forced to backtrack on the tariffs in the face of international pressure and a slowing economy.
Meanwhile, other countries have opted to placate Washington, offering to cut or altogether eliminate tariffs on US goods. That includes Israel and Vietnam, who announced measures even before Trump announced tariffs. At this point, it is unclear if the move will work, though Trump has repeatedly said he’s open to making a “deal”. The measures, and which countries can get reprieves and how, leave the market with even less certainty than before, which could keep the risk-off stance going for some time to come.