Euro-Dollar Under Pressure with U.S.-EU Trade Tensions Back on Radar

- EUR/USD under pressure amid strength in the USD.

- USD resilient after retail sales surprise on upside.

- Risks to EUR grow with threat of EU-U.S. skirmish.

- France turns to EU over Trump's digital tax retaliation.

- After EU trade commissioner says no "unity on trade".

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The Euro was under pressure Friday as the Dollar strengthened although the single currency is at increasing risk from a trade conflict between the U.S. and European Union, which has reappeared on the market's radar this week.

France's finance minister Bruno Le Maire said Friday the European Union would respond to any U.S. retaliation against President Emmanuel Macron's digital services tax that entered into force at the beginning of January and targets mainly U.S. companies, given American dominance in internet technology.

President Donald Trump has previously threatened to target French goods including wine and cheese with trade tariffs if the tax went ahead, which was just one of many incidences of the White House suggesting it could use punitive levies to force political changes in the EU or among its members. The prospect of an all-out U.S.-China style trade skirmish is arguably one of the greatest threats to the Euro this year, albeit that it's remained under the radar of late. 

"The euro remains the 3rd best performing G10 currency so far in January with the flow of macro-economic data offering hope of some modest rebound in economic growth in Q1 following the weakness last year. But we certainly see more risk now from a blow up in the US-EU trade spat following EU Trade Commissioner Phil Hogan’s visit to the US," says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG.

Above: Euro-to-Dollar rate shown at 4-hour intervals.

Friday's statement from Le Maire comes hard on the heels of Thursday's comments from EU trade commissioner Phil Hogan, who told reporters from Washington there'll be no "unity on trade between the EU and U.S. in the short-term," right after having complained that the long-elusive 'phase one deal' to suspend the tariff fight between the U.S. and China results in "managed trade" contrary to rules of the almost-defunct World Trade Organization (WTO).

The WTO's efforts to carry out its mission are being hampered by U.S. refusal to endorse the appointment of judges to its appellate body which has efffectively made the institution redundant because without judges it cannot mediate on and settle trade disputes. This is after years of complaints from Washington about the way the WTO does business, complaints which have increasingly turned to threats and (in)action under Trump's administration. 

"That explicit reference to the “short-term” suggests to us that the EU could well be braced for an imminent escalation," Halpenny says. "Under Section 301 procedures the US government is legally permitted to implement tariffs against foreign countries that violate existing agreements or engages in “unjustifiable” or “unreasonable” acts. The digital services tax has been deemed as such."

Above: Euro-to-Dollar rate shown at daily intervals.

The U.S. Treasury is consulting industry about a possible response to the digital tax, which is just the latest in a long line of U.S. grievances with the European Union on trade. The two sides have been in fruitless talks for nearly two years, with the aim of resolving a U.S. complaint about lopsided car tariffs and EU protectionism in the field of agriculture - which has seen much of the U.S. agricultural industry shut out of the EU market. 

Commissioner Hogan spoke Thursday of wanting a "reset" in U.S. and EU trade relations but years of talks have failed to produce any progress and its arguably doubtful that the White House will have patience for foot-dragging in an election year. Especially now that it's declared a small victory in the scrap with China.

There's a mounting risk that an emboldened Trump seeks to set the stage for a post-election showdown with the EU in a similar manner to how he did with China in 2016 and on the newly-renegotiated North American Free Trade Agreement. BofA Global Research told Pound Sterling Live last week this could become a more prominent risk for the Euro later in 2020, although the team is bullish in its outlook for the currency owing to a bearish view on the Dollar, which might suffer from election uncertainty.

Above: Logarithmic price scaled chart of Euro-to-Dollar rate at weekly intervals.

"We forecast EURUSD at 1.15 by the end of this year. We consider it to be a conservative estimate, being well below our equilibrium estimate of 1.20-1.25," says BofA's Athanasios Vamvakidis in a research note earlier this week. "The trajectory of relative data justifies a weaker USD, in our view. And looking ahead, we expect relative growth to gradually shift increasingly against the USD. We see the risk of a hawkish ECB surprise later in the year and generally see other risks as skewed to the downside for USD."

Much about the outlook for the Euro-to-Dollar rate depends on the relative performance of the economies behind those currencies, as well as the respective central banks. Markets see the U.S. economy slowing this year and the Federal Reserve, if it does anything, as biased toward cutting rates rather than raising them. Meanwhile, the prospect of a continental economic data rebound, not to mention technical constraints, could see European Central Bank (ECB) rhetoric ultimately lift the Euro. 

Analyst and investor opinion is divided on the outlook for the two economies and their interest rates, which could all be wounded or otherwise influenced to the downside by a U.S.-EU trade skirmish. Election uncertainty and its possible implications for Trumpian economic and foreign policy could well wobble the Dollar this year but some doubt that Europe's single currency will sustain gains for very long, partly because of what a rising currency might mean for the ECB.  

"On trade the Eurozone is cornered by Donald Trump, and it is not entirely clear that these defensive US policies will end entirely if Trump fails to get re-elected in November. In theory, a more defensive White House should be EUR supportive because it reduces the likelihood of a EUR devaluation. However, if the EUR doesn't remain weak it then becomes a drag on the Eurozone's growth & inflation dynamic, which is already very sluggish," says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

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