EUR/USD has come under pressure following an equity sell-off and softer German PMI readings, reinforcing the idea of a US–EU growth divergence. Germany’s services PMI fell to 46.8 from 48.1, which pushed the composite deeper into contraction, while the eurozone composite held at 49.5, close to returning to expansion. ING also points to a wider EUR:USD two-year swap rate differential, now at its broadest since September, alongside a renewed US dollar risk premium.
On the monetary policy front, ECB Chief Economist Philip Lane warned inflation is likely to remain above 2% for some time, a message that contrasted with earlier dovish communication and may prompt further hawkish remarks from other ECB officials. Near term, EUR/USD is seen at risk of testing 1.1300, even as the pair is trading at roughly 1% below a short-term fair value estimate, with medium-term scope for recovery if Fed hawkish bets are gradually pared back.
Growth And Policy Divergence Drives EUR/USD Weakness
We see the narrative of diverging growth between the US and Europe gaining strength, putting pressure on the EUR/USD. Germany’s recent IFO Business Climate index came in weak at 87.5, while US inflation remains sticky above 3.0%, reinforcing the view that the Federal Reserve will hold rates higher for longer. This fundamental backdrop supports a stronger dollar in the near term.
The European Central Bank’s decision to cut rates by 25 basis points earlier this month, a move driven by cooling Eurozone inflation now at 2.4%, stands in stark contrast to the Fed’s hawkish pause. This widening policy and rate differential naturally weighs on the euro. The two-year yield spread between German and US bonds has widened to its largest point this year, making dollar-denominated assets more attractive.
Positioning And Outlook For EUR/USD
Given this environment, we believe positioning for further downside in the coming weeks is prudent. We are looking at buying put options with strike prices around 1.0600 to hedge against or speculate on a move lower. Implied volatility in the pair has remained relatively subdued, making protective options strategies relatively inexpensive at present.
Despite the short-term pressure, we see the pair as becoming undervalued, similar to what we observed in late 2023 before a significant rebound. This suggests the market may be overly pessimistic on the Eurozone’s outlook, creating a potential opportunity for a recovery in the coming months. For traders with a multi-month horizon, selling out-of-the-money puts could be a way to collect premium while positioning for an eventual floor in the pair.
The immediate risk of testing the year-to-date lows near 1.0650 is growing, especially if ongoing jitters in equity markets continue to boost the safe-haven appeal of the dollar. Even though we feel the pair is trading below its short-term fair value, negative momentum is the dominant force. We are watching these key levels closely for signs of seller exhaustion.
