How US–Europe Tensions Could Impact the Euro

How US–Europe Tensions Could Impact the Euro

Why trade uncertainty may support EUR/USD – and what it means for investors

Renewed political tensions between the United States and Europe, triggered by disputes linked to Greenland and trade policy, have put the spotlight back on the euro. While the risks to European economic growth are real, currency markets are responding in a more complex way, with signs that escalation could actually support the euro against the US dollar.

Trade Tensions Return, but Tariffs Paused

The immediate threat of a new 10% US tariff on imports from eight European countries has eased after Washington withdrew the proposal amid signs of a potential deal.

However, the episode has reminded investors that trade and political uncertainty is back on the agenda. Even without tariffs in place, markets are now pricing in a higher risk of renewed escalation, which can influence currencies, equities and bond markets.

Why Escalation Can Support the Euro

According to analysts at Bank of America, the euro-dollar exchange rate sits at the centre of two opposing forces.

On one hand, any escalation in US–Europe relations threatens European growth. Slower growth would normally weaken the euro, particularly if it reduces exports and business investment.

On the other hand, Europe plays a critical role in financing the US current account deficit. When political or trade tensions rise, global investors may become less willing to fund US deficits, which can weaken the dollar instead.

Recent market moves suggest this second effect has been more influential.

What Recent Market Moves Tell Us

During the latest escalation scare:

• US equities fell
• US bond yields rose
• Market volatility increased
• The euro strengthened against the dollar

Bank of America notes that while the reaction was milder than during the tariff shock of April 2025, the direction was consistent. Historically, the euro has often risen following surprise tariff escalation involving the EU.

The bank estimates that, on average, the euro has gained around 1% above trend in the week following similar events.

Why the Economic Damage May Be Limited

If tariffs were reintroduced but limited to the eight countries originally targeted, the overall economic impact on Europe would likely be contained.

Those countries account for roughly 11% of US imports, and most sit within the EU single market. This allows trade flows to adjust, softening the immediate hit.

The bigger risk is not tariffs themselves, but persistent uncertainty. Prolonged political tension can delay investment decisions, weigh on business confidence and gradually slow European growth.

Medium-Term Factors Supporting the Euro

Beyond trade headlines, broader structural trends are also influencing the euro:

• Stronger political momentum for European fiscal spending
• Greater coordination around defence and infrastructure investment
• A relative shift in how markets view US growth, deficits and real yields

Notably, higher US real interest rates are no longer translating into a stronger dollar against the euro in the way they once did, suggesting a change in market dynamics.

A coordinated EU response to US pressure, particularly focused on services rather than goods, could further support the euro if escalation remains contained.

What This Means for Investing Strategies

For investors, US–Europe tensions have several important implications:

• Currency exposure matters: A stronger euro could benefit euro-denominated assets while reducing returns on unhedged US investments for European investors.
• Diversification becomes more valuable: Political risk reinforces the case for spreading exposure across regions and asset classes.
• Volatility may create opportunities: Short-term swings in currencies and equities can offer tactical entry points for active investors.
• Defensive assets may regain appeal: Rising uncertainty often supports assets such as gold and high-quality government bonds.

Outlook: Uncertainty, but Not Panic

While a full-scale trade conflict would be negative for growth on both sides of the Atlantic, current market behaviour suggests investors are more focused on capital flows and funding risks than on tariffs alone.

As long as escalation remains limited, the euro could continue to find support during periods of US–Europe tension. For investors, the key will be managing currency risk and staying alert to how political developments feed through into markets.

Sources: (Investing.com, Reuters.com)