EUR/USD edged lower to about 1.1415 in early Asian trading on Tuesday as positioning shifted on the outlook for European Central Bank rate increases. Christine Lagarde, opening the ECB’s annual retreat on Monday, said Europe is becoming less vulnerable to external shocks on the back of an improved financial framework and progress on the green transition. She also referred to tensions easing under a peace deal that remains “far from assured”, leaving policymakers to weigh whether further monetary tightening is required.
Expectations for additional ECB moves have been trimmed as energy prices retreat. Oxford Economics and Capital Economics foresee no further increases, although markets still price one more quarter-point rise that would take the deposit rate to 2.50%. In the US, the rate path has been repriced higher, with traders attaching nearly a 60% probability to a Federal Reserve hike by September, based on the CME FedWatch tool. Attention later this week turns to US ADP employment and Nonfarm Payrolls data, which could shape the Fed’s policy stance.
Divergence in ECB and Fed Policy Drives EUR/USD Lower
We see the EUR/USD pair facing downward pressure, currently trading around 1.0750. The primary driver is a growing divergence in monetary policy expectations between the European Central Bank (ECB) and the US Federal Reserve (Fed). This suggests the path of least resistance for the pair is lower in the coming weeks.
The view on the ECB has softened considerably after the latest Eurostat flash estimate showed June 2026 inflation falling to 1.9%, just under the central bank’s target. Historically, when inflation undershoots targets, central banks pivot to a more dovish stance. Derivative markets are now pricing in a greater than 70% probability of an ECB rate cut by September, a sharp reversal from just a month ago.
Conversely, the outlook for US interest rates has become more hawkish. The most recent Core PCE Price Index, the Fed’s preferred inflation gauge, came in unexpectedly high at 3.1% year-over-year for May 2026. This persistent inflation is forcing the market to reconsider the possibility of another Fed rate hike this year.
Market Positioning and Trading Strategy
This shift is reflected in fed funds futures, which now imply a nearly 50% chance of a 25-basis-point hike from the Fed by its September meeting. All eyes are now on this week’s US Nonfarm Payrolls report for June. Another strong jobs number, similar to the robust figures seen earlier this year, would likely cement these hawkish expectations and add further strength to the US dollar.
Given this backdrop, we believe positioning for further EUR/USD weakness is prudent. Buying euro put options with expirations in late July or August offers a defined-risk way to capitalize on a potential decline. This strategy allows traders to benefit from increased volatility and downside momentum, particularly heading into the pivotal US employment data release.
