MUFG said the US Dollar index (DXY) was trading just below its year-to-date highs, with the US dollar recording a second consecutive weekly gain after a hawkish Federal Reserve update. The bank pointed to wider expectations of monetary policy divergence between the Fed and major European central banks, a dynamic it linked to the recent move in the greenback.
For EUR/USD, MUFG set out two paths for the rest of the year: if the Fed does not follow through with rate hikes, it sees a return to the 1.1400–1.1800 range that has prevailed over the past year; if the Fed delivers multiple hikes, it sees EUR/USD dropping below 1.1000. MUFG also kept its long USD/NOK recommendation in place while it awaits evidence that the hawkish repricing of Fed rate expectations is being challenged, and it flagged the ECB annual policy forum in Sintra this week as a potential source of further guidance on transatlantic policy divergence.
US Dollar Strength and Monetary Policy Divergence
We see the US Dollar Index holding strong near 106.50, driven by a clear policy split between the Federal Reserve and other central banks. This echoes the dollar rally seen in 2022 when the Fed hiked rates aggressively ahead of its global peers. The latest US inflation data, showing core CPI stubbornly at 3.1%, gives the Fed little reason to change its hawkish tone.
In contrast, the Eurozone’s inflation just dipped to 2.2%, putting it very close to the European Central Bank’s target and reducing pressure for further rate hikes. This growing divergence underpins our view that the euro will likely weaken against the dollar. We will be closely watching for any new forward guidance from the upcoming ECB policy forum.
Implications for EUR/USD and Trading Strategies
For derivative traders, this situation suggests a higher probability of EUR/USD breaking lower in the coming weeks. With the pair currently trading around 1.1180, we believe buying put options with a strike price around 1.1000 offers a compelling risk-reward profile. This strategy allows for profiting from a downward move while clearly defining the maximum potential loss.
The evidence points toward continued US economic resilience, as the latest jobs report showed a healthy 215,000 new payrolls added. A less hawkish Fed or signs of slowing US inflation would challenge this view, but current data does not support that case. Therefore, we feel comfortable holding positions that benefit from a stronger dollar.
We are also maintaining our long USD/NOK recommendation, a trade that also benefits from broad dollar strength. Norway’s central bank has signaled a potential pause in its own hiking cycle amid concerns over slowing European growth, which adds another layer of support for this position. The trade remains attractive until we see a significant shift in Fed rate expectations.
