12.05.202601:08 Forex Analysis & Reviews: Trade Wars and Economic Challenges: The Euro at a Crossroads

Tensions in trade relations between the US and the EU are escalating once again. President Trump has set a July 4 deadline for the European Union to ratify a trade agreement, threatening to impose higher tariffs if it does not. He has previously stated his intention to impose 25% tariffs on imported cars as early as this week. These threats come in the wake of a US Supreme Court decision that deemed the so-called "mirror" tariffs illegal.

Meanwhile, the European Central Bank last week expressed concerns about the rising risks of both accelerating inflation and slowing economic growth. Markets are assessing the probability of an ECB interest rate hike at its June meeting at approximately 80%. Although this probability has decreased slightly from the previous week, tightening monetary policy appears to be practically settled. The ECB seems to be prioritizing price stability, even if that may slow economic growth. Market expectations suggest four rate hikes by the end of the year, which is a strong argument in favor of further euro growth. This factor, along with clear signs of dollar weakness, could support the strengthening of the European currency, if not for the uncertainty factor that could drastically change the situation.

Europe is critically dependent on external energy supplies. While oil prices have risen sharply since the beginning of the conflict, gas prices have held steady. This may largely explain the euro's current stability.

If hopes for a quick resolution of the Gulf conflict are realized, this could serve as a powerful stimulus for euro growth, bolstered by rising yields. However, if this scenario does not materialize, Europe will face serious issues with the physical supply of oil, especially gas. This would deal a heavy blow to European industry and is highly likely to lead to a recession. In such a case, the ECB's subsequent actions remain unclear. The services PMI index has already fallen below the 50 mark, signaling a downturn. The manufacturing index is holding up better so far, as the energy crisis has not yet fully manifested, but it is only a matter of time. The economic sentiment indicator, reflecting business and consumer confidence, has reached its lowest point since the end of 2022, surpassing even the levels observed during the energy shock of 2021-2023.

The net long position in euros decreased by $0.5 billion over the reporting week. While positioning is close to neutral, the calculated euro price shows a persistent downward trend.

Thus, we are witnessing the development of two opposing trends. Hopes for a resolution of the conflict and predictions regarding the ECB's interest rate support potential euro growth. If the first factor materializes, a breakout above the 1.1850 level and a move towards the 1.2083 high are possible. At the same time, the dynamics of the calculated price, which account for long-term fundamental factors, indicate a high probability that the euro will fall if the conflict continues. We consider this latter option more likely and expect a decline towards the support level of 1.1640/60.