The EUR/USD increased to 1.1643 due to eased tensions from the US-China trade discussions held in Malaysia. These negotiations have set the groundwork for a possible agreement on tariffs and rare earths, just as traders anticipate a 97% likelihood of a 25 basis point rate cut by the Federal Reserve.

The currency pair saw a 0.15% rise late Monday during the de-escalation of the US-China trade war, preceding an expected meeting between Trump and Xi Jinping. Meanwhile, the US Dollar Index slightly rose to 98.94, restricting further gains for EUR/USD, as traders await the Federal Reserve’s monetary policy decision.

Eurozone Business Survey

The Eurozone’s IFO Business Survey indicated businesses foresee potential economic improvement despite current conditions being less favourable. Interest rates expectations are pivotal, with traders focusing on clearing technical resistance levels for EUR/USD at 1.1659 and 1.1686.

The Euro has presented variable percentage changes against major global currencies, illustrating stronger performances against the Japanese Yen but mixed against others. Overall, Eurozone economic data, such as GDP and consumer sentiment, significantly impact the Euro’s value by influencing investment and ECB rate decisions.

Looking back at the dynamics from the Trump era, we can see how quickly risk sentiment around trade and central banks can move the EUR/USD. While the pair traded above 1.16 back then on hopes of a trade truce, today we see it navigating the 1.0750 level under a different set of pressures. The main driver is no longer trade tariffs but a clear divergence in monetary policy.

Monetary Policy Divergence

The US Federal Reserve has held its benchmark rate steady at 5.50% for several months now, after the aggressive hiking cycle of 2023 successfully brought inflation down. Markets are now anticipating the Fed’s next move to be a cut, with the CME FedWatch tool indicating a greater than 60% probability of a rate reduction in the first quarter of 2026. This anticipation is putting a cap on the US Dollar’s strength.

In contrast, the European Central Bank is dealing with more persistent inflation, with the latest Harmonized Index of Consumer Prices (HICP) data showing core inflation stubbornly at 2.7%, still well above the 2% target. ECB officials have maintained a hawkish tone, suggesting that they are not yet ready to consider easing policy. This creates a fundamental tension that derivative traders can position for.

Given this uncertainty about the timing of central bank pivots, volatility in EUR/USD is expected to rise from its current low levels. We believe purchasing at-the-money straddles or strangles with expirations in the next 30 to 60 days is a prudent strategy. This allows traders to profit from a significant price move in either direction, without having to correctly predict whether the Fed or the ECB will signal a policy shift first.

For traders with a directional bias, the current setup favors an eventual rise in the EUR/USD as the Fed is positioned to cut rates before the ECB. Buying call options or implementing bull call spreads targeting the 1.0900 level offers a low-premium way to capture potential upside. The key is to watch upcoming US labor market data and Eurozone inflation prints, as any surprises will dictate the timing of a breakout.

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