USD: Pulling at the Strings of an Accord

We remain skeptical of a centrally-planned currency accord but acknowledge shifting global policies could create conditions to weaken the Dollar. Historical blueprints like the Plaza Accord or Smithsonian Agreement don’t align with today’s macro setup. Successful FX intervention requires market forces to align with policy, which isn’t the case now. Unlike the 70s and 80s, today’s FX market is driven by private capital, not official demand. The strong Dollar of the last decade stems from private capital seeking higher returns, not reserve managers.

A plausible path to a currency “deal” involves reversing this trend through fiscal shifts: US fiscal consolidation and increased spending by key trading partners like the EU and China to boost domestic demand and curb US protectionist policies. This aligns with the "Mar-a-Lago Accord" concept, though some arguments fall short. Japan, for instance, plays a marginal role due to the dominance of private capital and the shifting US trade balance.

Efforts to weaken the Dollar may be overstated, as achieving this requires coordinated policies that conflict with US goals like raising tariffs and cutting taxes. The US is unlikely to abandon its policy agenda, which remains Dollar-positive. However, Europe’s expected increase in defense spending, including US equipment purchases, signals halting progress. This process will be slow, and the US effective tariff rate is projected to rise significantly this year.

Ultimately, the Dollar’s outlook hinges on the balance between US policy changes and foreign responses, which currently reflect discord rather than accord. This evolving balance slightly tempers our expectations of Dollar strength over the next year.

EUR: Revising EUR/USD forecast upward.

While we still expect tariffs and uncertainty to weigh on Eurozone growth, widening the US-Euro divergence and pushing EUR/USD below parity, recent developments suggest a more moderate Dollar appreciation.

1. Trade uncertainty's impact on the Eurozone has been contained, while US policy uncertainty is affecting sentiment and tightening financial conditions.

2. Tariffs may be less impactful than anticipated, with stable USD/CNY mitigating broader FX volatility.

3. Faster-than-expected peace talks and increased EU fiscal spending, including on defense, could boost growth.

However, risks remain. Disagreements on the Russia-Ukraine peace process and potential heavier tariff impacts on Europe highlight ongoing instability. The market appears overly optimistic, underpricing risks. We revise EUR/USD forecasts to 1.02 (3 months), 1.01 (6 months), and 0.99 (12 months), up from prior estimates of 1.00, 0.97, and 0.97, as the Dollar’s strength remains underappreciated.