EUR USD Exchange Rate Pushes Higher As US Budget Points Towards 1 Trillion Dollar Deficit

February 13, 2018 - Written by Frank Davies

STORY LINK EUR USD Exchange Rate Pushes Higher As US Budget Points Towards 1 Trillion Dollar Deficit

Markets did not react positively to the announcement of the US 2019 Fiscal Year Budget, prompting the Euro US Dollar (EUR/USD) exchange rate to trend sharply higher.

Particularly concerning was the fact that the budget proposals would result in the US deficit hitting 1 trillion US Dollars in the next year, with the national debt looking set to remain at this elevated level over the forecast period.

This encouraged investors to pile out of the US Dollar, exacerbating long-held market worries over the ultimate economic impact of the Trump administration’s policies and tax reforms.

With global stock markets also continuing to recover ground there was little to weigh down the EUR USD exchange rate on Tuesday morning.

Worries Over US Deficit Weigh Heavily on US Dollar Exchange Rates

The impact of the proposed budget – even though it is unlikely to be adopted by Congress in this form – is likely to keep USD exchange rates under pressure in the near term.

As researchers at Rabobank noted:

‘The US deficit –and lack of urgency in the US government– is gaining increasing attention, both from officials and from markets. As Mr. Blanchard put it, “it’s the wrong timing for a deficit” now that the US economy is expanding relatively quickly. Indeed, the timing could have been better. Further loosening of the fiscal reins, adding to government debt, could put further upward pressure on US yields. Moreover, were Trump’s budget plans to be adopted and were these plans, together with Trump’s tax reforms, to lead to higher growth, this could force the Fed to speed up its tightening pace – again adding to higher yields. Admittedly, those are still a lot of ‘ifs’.’

Speculation over the likely pace of the Federal Reserve’s monetary tightening is expected to pick up ahead of Wednesday’s US consumer price index report.

While the CPI is not the Fed’s preferred measure of inflation a weaker showing here could still have a negative impact on the odds of the central bank pursuing a more aggressive cycle of interest rate hikes.

As forecasts point towards a modest easing in price pressures, with the headline rate expected to dip from 2.1% to 1.9%, the mood towards the US Dollar could sour further.

However, an upside surprise may well be enough to reverse the current uptrend of the EUR USD exchange rate, giving the Fed further encouragement to raise interest rates at its March policy meeting.

EUR USD Exchange Rate Upside Forecast on Solid Eurozone GDP Figures

Increased volatility will also be in store for the Euro on Wednesday, with the release of the provisional fourth quarter Eurozone and German gross domestic product figures.

Signs that the currency union maintained its solid momentum in the fourth quarter, capping off an impressive year of economic growth in 2017, could push the EUR USD exchange rate sharply higher.

Anything short of a significant downside disappointment is likely to support demand for the single currency, as the Eurozone looks set to enjoy another year of bumper growth in 2018.

Even so, the positive mood could still be somewhat muted by confirmation that German inflation contracted on the month in January.

In spite of the more dovish tone of recent comments from European Central Bank (ECB) President Mario Draghi a solid round of GDP data could still encourage hopes that policymakers will shift to a more hawkish outlook.

Either way, the chances of the ECB taking a more aggressive approach to monetary policy in the coming months are likely to remain low.

As analysts at BBH commented:

‘We detect a shift in expectations among many investors. Previously, many had seemed to believe that the ECB would end its purchases when the current program ends in September. However, now, with the encouragement of even some of the (perceived) more hawkish members, it seems that many now accept that the purchases will likely be gradually tapered than stopped cold. There is an important difference between cutting from 60 bln euros a month to 30 bln a month in purchases than going from 30 bln to none.’

Persistent jitters over the fate of the proposed German coalition government could also limit the upside potential of the EUR USD exchange rate this week.

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TAGS: Euro Forecasts