MUFG said EUR/USD could find support if the US dollar weakens and the European Central Bank remains hawkish, with the rates curve still pricing in another hike even as US yields ease on softer Federal Reserve rate expectations after the payrolls report. The bank linked the euro’s inflation backdrop to energy markets, arguing that Europe’s inflation risks have eased but remain higher than before the conflict.
Brent crude has fully unwound its post-conflict jump, but LNG prices are still 40% above pre-conflict levels, keeping energy-led inflation risks in focus for the Eurozone. MUFG expects the ECB to track energy price retracement following the ceasefire extension and the reopening of the Strait of Hormuz, judging that the move so far is insufficient to remove energy-related inflation risks and therefore leaving the bank biased towards another rate increase.
Fed Pause and Dollar Weakness
We see the latest US non-farm payrolls report, which came in at 155,000 against expectations of 180,000, as a key driver for dollar weakness. This reinforces the view that the Federal Reserve will pause its tightening cycle, causing US yields to fall. Consequently, derivative traders should consider strategies that benefit from a declining dollar, especially against the euro.
Eurozone Inflation and Policy Divergence
In the Eurozone, inflation remains a concern even though it has subsided from its peaks. The latest Harmonised Index of Consumer Prices (HICP) reading of 2.8% is still well above the European Central Bank’s 2% target. This persistent inflation keeps the ECB biased towards one more potential rate hike.
A primary inflation risk comes from energy, specifically Liquefied Natural Gas (LNG) prices. While crude oil has stabilized, European TTF natural gas futures are holding near €35 per megawatt-hour, which is significantly elevated compared to pre-2022 levels. We believe the ECB is closely monitoring this, as it poses a continued threat that prevents them from fully pivoting to a dovish stance.
This policy divergence between a pausing Fed and a still-hawkish ECB creates a supportive environment for EUR/USD, which is currently testing the 1.1050 level. We anticipate that options traders may favor buying euro calls or implementing bull call spreads to capitalize on potential upside in the pair. This positioning reflects the growing interest rate differential that favors the euro in the near term.
