EUR/USD started the week slightly lower, trading near 1.1860 in the Asian session on Monday and holding losses around 1.1850. Trading was subdued because US markets were closed for Presidents’ Day and Mainland China was shut for the week-long Lunar New Year holiday.
The downside in the pair was limited as the US Dollar eased after softer January inflation data increased expectations of Federal Reserve rate cuts later in 2026. US CPI rose 2.4% year-on-year in January, down from 2.7% in December and below the 2.5% forecast, while monthly CPI was 0.2% versus 0.3% previously and 0.3% expected.
Fed Policy Expectations
US labour data showed Nonfarm Payrolls rose by the most in over a year and the Unemployment Rate fell unexpectedly, suggesting a steady jobs market. Markets expect the Fed to leave rates unchanged in March, then deliver two 25-basis-point cuts by year-end.
The CME FedWatch tool showed nearly a 90% probability of no March change, up from 81% a week earlier. Markets put the first cut in June at about a 52% probability.
The euro was supported by signals that the ECB is not concerned about recent euro strength. ECB President Christine Lagarde said the euro area inflation outlook is in a “good place” and warned against reacting to short-term or volatile data.
Looking back at the analysis from this time last year, we can see the market was positioned for US Dollar weakness with EUR/USD trading near 1.1850. Expectations in February 2025 were centered on a soft 2.4% inflation reading, which fueled bets on two Federal Reserve rate cuts by the end of that year. This outlook, however, proved to be overly optimistic as the US economy showed more persistence than anticipated.
Throughout the second half of 2025, inflation remained stickier than expected, with core CPI averaging 2.9% and preventing the Fed from cutting rates as aggressively as the market had priced. The Fed ultimately delivered only a single 25-basis-point cut in November 2025, a stark contrast to the European Central Bank which began its easing cycle in September. This policy divergence was a primary driver that pushed the EUR/USD down toward the 1.1200 level by the end of the year.
Strategy And Volatility
Now, the most recent data from January 2026 shows US CPI ticking back up to 3.1%, surprising analysts and putting future Fed rate cuts in doubt. Meanwhile, the latest Eurozone Harmonised Index of Consumer Prices (HICP) fell to 2.2%, with several ECB officials now publicly discussing the need for further stimulus. This widening gap in economic performance and central bank rhetoric is setting the tone for the market.
Given this divergence, derivative traders should anticipate further downside pressure on the EUR/USD in the coming weeks. We believe purchasing put options with a strike price around 1.1000 or establishing bear put spreads could be a prudent strategy. These positions would benefit from a move lower as the market continues to price in a more hawkish Fed against an increasingly dovish ECB.
We are also seeing implied volatility on one-month EUR/USD options rise to 8.1%, up from a low of 6.7% just two months ago. This indicates the market is bracing for larger price movements. Therefore, traders should consider that while the direction seems clear, the cost of implementing these option strategies is increasing and requires careful position sizing.
