The euro has surpassed its recent highs, reaching a level not seen since October 2021. European leaders’ commitment to increase NATO spending may precede relaxed fiscal regulations in the eurozone.
The US dollar is weakening, influenced by the resolution of tensions in the Iran-Israel conflict. The euro’s rise is part of a trend initiated by increased German fiscal spending and past trade disputes.
US Inflation Factors
Inflation and potential US rate cuts are affecting the dollar’s short-term performance. The ECB remains inactive, while Morgan Stanley predicts significant rate cuts by the Fed next year.
US inflation data, including the forthcoming PCE report, is essential in this financial equation. If tariffs do not drastically increase prices, this could lead to dollar-weakening rate cuts. Markets currently anticipate 104 basis points of easing next year, although this is subject to change.
There is little significant resistance on the euro chart until 1.20 or 1.22. The recent positive movement signals a favourable outlook.
What we’ve seen so far is a relatively sharp move in favour of the common currency, extending past previous barriers set in early Q4 of 2021. This upswing has come at a time when broader market sentiment has moved away from defensive positioning and has tilted more towards growth-sensitive assets. The recent push among eurozone members to raise NATO contributions, while perhaps appearing geopolitical at surface level, may be giving investors confidence that public finances will also be marshalled towards longer-term support—or at least that fiscal constraints could be relaxed from the stringent post-crisis levels previously endorsed. Ultimately, that removes a headwind for euro appreciation.
The dollar, by contrast, has come under pressure, in no small part due to the cooling of tensions in the Middle East. This kind of geopolitical relief tends to favour carry trades and reduces flight-to-safety flows into the greenback. It’s not just risk sentiment at play in the foreign exchange markets, though. Macro data carries plenty of weight too. Recent inflation readings out of Washington have shown a drifting pattern rather than something more anchored or consistent. Traders are now leaning more heavily into the idea of rate reductions from the Federal Reserve, and not in a symbolic way—current pricing implies over 100 basis points being withdrawn in 2025, with the biggest shifts expected as early as spring.
Interest Rate Outlook
Gorman’s team anticipates an aggressive path lower for US interest rates, and this outlook is boosting the euro in relative terms. If that easing does materialise, especially in the absence of fresh tariffs causing another inflation spike, it would likely provide further room for short dollar positions to accumulate. But market consensus can shift rapidly; any retracement in core inflation numbers or payrolls could put the brakes on what has so far been steady support for this bet.
Technically, the way is clearer now than it has been in some time. From a chart perspective, we don’t see any dense resistance levels until around the 1.20 handle, and perhaps even beyond. Momentum indicators remain well-supported, and volume patterns suggest strong follow-through.
From our vantage point, there are distinct opportunities in rate-sensitive derivatives, especially where euro strength is being underpriced relative to future policy divergence. For those positioned along the interest rate curve, it may be worth observing how implied volatility shifts across options markets—particularly in euro-dollar rate spreads. Should dovish positioning deepen in US markets without a corresponding shift in Frankfurt, the asymmetry could be exploited using calendar spreads or delta-neutral strategies.
We also notice traders are underutilising shorter maturities in euro-denominated interest rate structures. There’s scope to capture positive carry without overcommitting to long-dated exposure. One needs to be precise here though; overnight indexed swaps are already embedding a fair amount of optimism about policy slant, and any breakdown between expected and realised central bank action could turn the tables rather quickly.
The euro’s path forward is clearer than it has been in months, but this does not mean it is without risk. Durable goods orders and forward-looking consumption metrics in the US will remain market-moving, and each release should be tracked against real yield differentials. As always, data surprises will dictate recalibration.
