The dollar smile (08/03/2025)

There have been quite a few interesting events to analyze this week, and below I list the most noteworthy news. Let’s get started:

• European stock markets are soaring at the start of the year. Germany is preparing for a radical shift in its fiscal and defense policies following an agreement between Friedrich Merz’s conservatives and the Social Democrats (SPD) to create a €500 billion infrastructure fund and loosen the country’s debt rules. The goal is twofold: to modernize the German military amid growing international instability and to revive an economy that has been in a technical recession for two years.

  Donald Trump’s return to the White House and his freezing of military aid to Ukraine have acted as the trigger to accelerate this shift. Berlin fears that Trump might strike a deal with Russia to resolve the Ukrainian conflict in exchange for disengaging from Europe, which would force the EU to strengthen its own defense capabilities without relying on Washington. Under this new paradigm, Merz summed up Germany’s position with a whatever it takes (Mario Draghi style) applied to defense: a clear message about Germany’s willingness to significantly ramp up military spending.

  The euro responded by rising, and German bond yields experienced a historic surge amid expectations of this fiscal shift, which aims to amend the constitutional debt brake imposed after the 2008 financial crisis. The reform would exclude from the debt brake calculation any defense spending exceeding 1% of GDP, while a commission will work on permanently adjusting the rules to facilitate public investment.

  From an economic perspective, the message is clear: Germany is breaking with fiscal orthodoxy to escape stagnation and regain both economic and geopolitical influence. As positive as the intentions may be (reindustrializing Europe), demographics, competitiveness, and energy dependence make it an unviable long-term plan, and the continent remains a structural short.

  In this context, the dollar continues to lose ground, hitting lows not seen since the U.S. elections in November. This contrasts with its historical behavior, where it has traditionally served as a safe haven during times of global tension, benefiting from the well-known “smile” of the greenback: it tends to rise both in high inflation and rising rate environments, as well as during episodes of major geopolitical disruption due to the U.S.’s role as a safe-haven asset.

  However, this time the deterioration of U.S. economic indicators and the decline in activity are breaking that classic pattern. The recession narrative in the U.S., combined with Europe’s renewed fiscal strength and the expectation of economic decoupling, is shifting capital flows toward other currencies, leaving the dollar without its usual support pillars on either end of the “smile.”

  

   

• Donald Trump has unleashed a new wave of trade wars after imposing 25% tariffs on imports from Mexico and Canada, as well as doubling tariffs on Chinese goods to 20%. These measures, justified on the grounds of curbing the flow of fentanyl into the U.S., directly impact around $2.2 trillion in annual trade with its three main trading partners and threaten to worsen the country’s economic slowdown while reigniting inflation.

  International reactions were swift. Canada responded with 25% tariffs on U.S. goods valued at $20.7 billion. Meanwhile, China implemented new tariffs of 10%-15% and imposed restrictions on U.S. companies, including sanctions on firms linked to arms sales to Taiwan.

  

   

  Markets reacted sharply: broad declines across stock exchanges, the Nasdaq entering correction territory, and a flight to safe-haven assets like U.S. Treasuries. At the same time, the Mexican peso and Canadian dollar depreciated, reflecting the growing tension surrounding North American trade. Beyond the immediate financial consequences, the tariff escalation has a direct impact on consumer prices. Companies like Target and Best Buy have already warned of imminent price increases on basic goods (while these may be a one-off, any longer-term disruption to supply chains and trade flows could trigger persistent inflationary pressures), from avocados to electronic devices. According to estimates from Nationwide Mutual, American households could face additional annual costs of up to $1,000 due to the tariff hikes, further complicating Trump’s campaign promise to reduce the cost of living. In essence, the White House has chosen a strategy of full-scale confrontation that, far from addressing the fentanyl problem, could result in significant self-inflicted economic damage.

  Just one day later, the White House confirmed that Trump will grant a one-month temporary exemption to automakers from Canada and Mexico from the new 25% tariffs, provided their vehicles comply with the strict content rules of the USMCA agreement. On that same Thursday, he also decided to extend an exemption until April 2 for all goods already covered under the North American trade agreement.

  This uncertainty (yes now, no tomorrow…) prevents companies from making any long-term investment decisions and, therefore, fails to support or revive the U.S. manufacturing sector. The impact of these tariffs would be devastating for all three countries, both in terms of GDP and inflation, so let’s hope common sense prevails.

  

   

• The day has come. The United States has signed an executive order to create a Strategic Bitcoin Reserve. However, the details of the announcement have slightly dampened the mood. The reserve will be constituted exclusively from BTC already seized by the U.S. government, disappointing those who were hoping for active purchases of new tokens by the Treasury. The measure, more symbolic than practical, marks the first official recognition of Bitcoin as a state reserve asset, but without allocating public funds to expand it or setting clear timelines for future acquisitions.

  

   

  Industry criticism has focused on the lack of real impact: there will be no additional purchases, and the so-called reserve is little more than a rebranding of BTC already held in custody following legal proceedings. In fact, Trump merely authorized the Departments of Commerce and Treasury to explore “cost-neutral” options for future purchases, but without any concrete commitments.

  Bitcoin is scarce, it’s valuable, and that is strategic for the United States to hold on to this as a long-term reserve asset.
  — David Sacks

  Personally, I’m not that skeptical, and I see this as a giant leap toward the adoption of Bitcoin as a store-of-value reserve asset and the transformation of the monetary system as we know it.

• After a few weeks of milder temperatures and some negative news—such as the easing of inventory replenishment mandates—natural gas prices have dropped sharply in Europe and Asia, although they remain well above their American counterparts, which have entered a new paradigm. Due to new export capacity (both land-based to Mexico and, more significantly, LNG terminals), the U.S. domestic market will shift from a structural surplus to a deficit, setting a floor and a new trading range for Henry Hub prices.

  

   

  It’s often difficult to put these values into context, so I’ve prepared this table comparing coal, natural gas, and oil prices across different scenarios. It clearly shows how the energy molecule in the United States is by far the cheapest in the world.

  

   

  On the liquids side, the story is different. Oil has been declining for eight consecutive weeks, despite its fundamentals not reflecting this weakness (although financial positioning does). The narrative that OPEC is surrendering with the reintroduction of 135,000 barrels per day (agreed upon starting in April) is exaggerated; the market can comfortably absorb that volume after scheduled maintenance, and it reduces the long-term idle capacity risk.

  It is true that the relationship between prices and inventories is not linear and that the reserves context has changed now that the U.S. is a net energy exporter. However, as shown in the following chart, current WTI prices are nearly two standard deviations below their historical relationship with inventory variations—an extremely significant statistical anomaly.

  

   

  The dominant narrative in the oil market follows a simple logic: increased OPEC+ production, Trump’s tariffs, and weak U.S. economic data will lead to slower growth and, therefore, lower crude prices. However, the bearish outlook overlooks several key factors:

  • Non-OPEC+ supply is beginning to show signs of exhaustion.

  • China has just announced a new fiscal stimulus package that could boost energy consumption in non-OECD economies.

  • Global oil inventories, which should be building up in this first quarter if there were truly an oversupply, are not increasing significantly.

  For me, the bullish thesis on oil remains intact.