The "de-dollarization" wave boosts the euro's performance. How can exchange rate volatility risks be mitigated?

The euro against the US dollar recently broke through the 1.17 level, reaching a new high for the year. This movement reflects not only exchange rate changes but also deeper shifts in global capital flows and geopolitical power struggles. As US-Europe trade tensions escalate, markets are reevaluating the dollar’s role as an international reserve currency, making euro forecasts increasingly complex.

Geopolitical Tensions Rise, US-Europe Tariff War Resumes

In mid-January, disputes over Greenland pushed US-Europe relations into a tense phase. US President Trump threatened tariffs on European goods, while Europe prepared retaliatory measures, fueling a rapid rise in protectionist sentiment. Meanwhile, the US dollar index fell sharply by 0.7%, indicating market concerns over US policy uncertainties.

These geopolitical risks not only impact Europe’s economic outlook but also trigger investors to reconsider asset allocations. The stable US-Europe economic relationship shows cracks, prompting market participants to seek alternative investments to the dollar.

Japanese Bond Market Turmoil Sparks Global Financial Chain Reaction

Japan is preparing for a general election, and Prime Minister Yoshihide Suga’s proposed reduction of the food consumption tax has sparked bond market panic. The yield on Japan’s 40-year government bonds surged to 4.24%, hitting a 40-year high, highlighting concerns over Japan’s fiscal outlook.

More notably, volatility in Japan’s bond market quickly transmitted to global markets. US Treasury yields rose accordingly, reinforcing expectations of tightening global liquidity. Against this backdrop, European investors are reassessing their asset allocations, adding more variables to euro forecasts.

Europe Sells Off US Assets, “De-dollarization” Resurges

George Saravelos, Head of FX Research at Deutsche Bank, pointed out that European countries hold up to $8 trillion in US bonds and stocks—almost twice the total held by other countries worldwide. In the current geopolitical environment, Europe may consider selling some US assets as a response.

“The developments over the past few days could further drive Europe’s rebalancing away from dollar assets,” Saravelos added. This suggests Europe might reduce its dollar holdings and shift toward other currencies or asset classes, exerting ongoing pressure on the dollar and boosting the euro.

Faron Credit analysts believe Trump’s tariff threats have reignited market “sell US” sentiment, but traders should not overlook a key variable: “TACO trades” (Trump’s brinkmanship). If Trump ultimately uses tariffs as a bargaining chip rather than a genuine threat, the dollar could rebound, putting downward pressure on the euro.

Euro Volatility Likely to Increase, Risk Warnings

Morgan Stanley previously warned that the euro could experience 10% or greater fluctuations. Analysts note that market participants are generally underestimating the risks of extreme scenarios, and the euro could swing 10% or more in either direction from current levels.

This means that whether European asset sell-offs intensify or “TACO trades” actually occur, euro forecasts face significant uncertainty. Investors need to closely monitor developments in US-Europe relations, Japanese policies, and global liquidity shifts to find opportunities amid currency volatility.

In the coming weeks, every euro fluctuation could serve as a signal for markets to reprice global assets.