Caught Between Reprieve and Repricing FX Markets React to Political Friction and Economic Reality

The US dollar is finally showing signs of pushback but not in the way many expected. While the recent US court decision temporarily halting the Trump-era tariff regime may seem supportive for risk sentiment, it hasn't spared the USD from logging a fourth consecutive monthly drop on the NEER, the longest such stretch since the post 2017 correction. And just like then, we may only be midway through the unwind.

DXY H1 Chart 

Markets remain deeply divided. On one hand, legal friction around tariff policy is slowing escalation of trade tensions a positive. But on the other, the political ambiguity heading into the summer and the ongoing fiscal battle in Congress are injecting a new layer of volatility into the USD outlook. It’s not about collapse, but correction and the pricing of that correction is far from done.

Looking ahead, the Fed finds itself in a tight corridor. Abating inflationary spillovers from tariffs and still-strong labour markets argue for patience, yet persistent uncertainties around fiscal stimulus and fragile risk sentiment suggest the door remains open to another insurance cut in the coming months. For now, FX traders are watching ISMs, NFPs, and Powell’s June 2 remarks for signals.

EUR: Dovish Drift Meets Overvaluation

The euro continues to ride the coattails of diversification flows and optimism around Eurozone fiscal stimulus. However, positioning is already heavy, and that makes the EUR vulnerable especially as the ECB gears up for another rate cut to 2.00% at its June meeting. The central bank is widely expected to downgrade growth and inflation projections, while keeping forward guidance vague. That’s not a bullish setup.

EURUSD H1 Chart 

Despite recent EUR strength, I think the currency’s relative overvaluation especially versus GBP and USD could cap further upside unless there’s a marked acceleration in fiscal rollout or a significant improvement in global risk sentiment. Keep a close eye on Lagarde’s commentary around the euro’s role as a reserve currency; dovish inflections could soften the bid.

GBP: Underappreciated Resilience

Sterling’s underperformance against the euro might be short-lived. The UK is now in an enviable position: a more constructive trade relationship with both the US and EU, sticky inflation that delays BoE easing, and arguably the cleanest fiscal sheet among G7 peers. In fact, gilt yields continue to lead G10, bolstering the GBP’s carry profile.

Still, GBP/USD remains at the mercy of broader USD dynamics. If global risk appetite revives as tariff uncertainty fades GBP could outperform in the second half of 2025. For now, speeches from BoE's Bailey and Greene, along with final May PMIs, will drive near-term sentiment.

JPY: Safe Haven or Mispriced Hedge?

The yen continues to benefit from its classic role as a hedge against US policy risk and market volatility, especially amid global bond market distortions. JGB auctions and Ministry of Finance commentary are keeping long-end Japanese yields in check, while a steeper US yield curve is pressuring USD/JPY lower.

Crucially, the BoJ remains on a tightening path albeit slow and conditional. With markets pricing only ~30% odds of a hike in 2025, any upside surprise in Japan’s capex or wage growth data could rapidly shift expectations. Meanwhile, Trump’s tariff saga is quietly reinforcing the yen’s defensive bid.

CHF: Strong, Steady, and Uninspiring

Switzerland’s currency is stuck literally. EUR/CHF has been rangebound between 0.93 and 0.94, with markets reluctant to push the franc much further in either direction. Inflation is softening, and SNB is content to lean on verbal guidance rather than FX intervention. With a 25bp cut already priced in, the CHF may slowly unwind its strength, but don’t expect a sharp move unless European inflation surprises to the upside.

AUD & NZD: Undervalued but Undecided

The Aussie and Kiwi both offer interesting setups, but patience is key. Australia’s tight labour market and post-election fiscal stimulus should anchor inflation expectations, giving the RBA room to pause rather than pivot. At the same time, China’s continued economic stimulus indirectly supports the AUD via the CNY correlation. Yet, global risk-off tones and lingering trade headwinds are keeping a lid on bullish sentiment.

In New Zealand, the economic rebound is real thanks largely to agri-exports and an improving trade balance. The NZD remains undervalued versus macro fundamentals and should benefit if Asia-US equity performance gaps narrow. However, structural fragilities and USD volatility could delay the realization of that upside.

Gold: Breather Before Another Leg Higher?

Despite recent aggressive gains, gold may not be done. Central bank buying and an eventual Fed easing cycle could align to push real yields lower, reigniting bullish flows into XAU. Unless we see a material rebound in US growth expectations and long-end yields, the path of least resistance remains up. Expect consolidation short-term but positioning suggests another leg higher within three to six months.

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