The dollar is inching off a two-year low as investors adopt a defensive posture ahead of this morning’s Job Openings and Labor Turnover report, which is expected to confirm a cooling in US labour market conditions ahead of Friday’s non-farm payrolls report. Mentions of layoffs on corporate earnings calls have been minimal, and unemployment claims remain well below levels that have historically signalled growing stress, but economists have drastically lowered job creation forecasts*, and market participants are bracing for an imminent slowdown. Treasury yields are slipping as traders anticipate more easing from the Federal Reserve, North American equity indices are pointing to a dip at the open, and most major currencies are nursing modest losses against the greenback.

A report published yesterday showed US factory activity slipping further into contractionary territory last month, with respondent comments placing the blame squarely on tariff-related policy changes. The Institute for Supply Management’s manufacturing index slipped to 48.5 in May from 48.7 previously, remaining below the 50 threshold that separates expansion from contraction for a third consecutive month. The imports sub-index fell to the lowest levels recorded since the global financial crisis, inventories slipped, delivery times lengthened, and new export orders dropped at a rate typical of recessions, suggesting that retaliatory measures in other countries took a toll. 86 percent of the survey’s participants mentioned tariffs in their comments, and many drew direct comparisons with the supply chain conditions experienced during global lockdowns in early 2020.

Across the pond, the euro is losing altitude after bloc-wide inflation slowed more than expected last month. According to Eurostat, underlying core price growth slowed to 2.3 percent in May, down from 2.7 percent in the previous month on a slowdown in services inflation to 3.2 percent from 4.0 percent. The European Central Bank is widely expected to cut rates for an eighth time on Thursday, with at least one additional move coming in the autumn as wage-driven inflation risks subside, energy prices fall, and growth remains weak.

Despite this dovish policy backdrop, options traders haven’t been as optimistic on the euro’s upside potential relative to the dollar since 2007**. Risk reversals—which measure the difference between puts and calls for the same expiries—are skewed toward euro-positive outcomes, and are increasingly skewed over longer time horizons, suggesting that market participants expect gains to accelerate over the year ahead.

We find this difficult to justify. There are good reasons to think that a narrowing in cross-Atlantic growth differentials and a gradual diversification away from American assets might help correct overvaluation in the dollar in the years ahead, but in the here and now, the euro area is still facing serious structural headwinds. Chronic underinvestment is weighing on productivity growth, while rigid labour markets and an ageing population constrain dynamism. Heavy regulatory burdens slow innovation, and mean that big stimulus efforts—such as Germany’s recent fiscal expansion—can take years to impact growth trajectories. Meanwhile, geopolitical tensions on the bloc’s eastern flank and an overreliance on external demand expose the region to global volatility. There are signs that deeper integration and reform efforts could gain traction—especially if led by former European Central Bank president Mario Draghi—but those are unlikely to reshape fundamentals in the near term, or sustain the repatriation of hundreds of billions in offshore assets. For now, the bloc remains a slow-growth area in an increasingly multipolar world, and the common currency’s upside potential seems limited.

*Apologies to Apollo Global’s Torsten Slok, who—after I created this one of course—published a chart exploring a similar concept this morning. His daily charts are phenomenal. Do subscribe.

**With the exception of a three-day period during the 2020 selloff.