EUR/USD edged up to about 1.1655 in early Asian trade on Friday as the euro firmed after reports of tentative progress towards a US-Iran ceasefire extension. CNN said the sides had discussed reopening the Strait of Hormuz and beginning nuclear talks, although President Donald Trump had yet to approve any arrangement and Iranian officials had not commented. Markets also awaited Germany’s preliminary inflation data due later on Friday.
In the US, annual Personal Consumption Expenditures (PCE) inflation was in line with forecasts, while the softer monthly print added to expectations that price pressures may be easing, a backdrop that could keep the Federal Reserve holding rates steady for longer. The euro remains central to global FX flows: in 2022 it accounted for 31% of transactions, with average daily turnover above $2.2 trillion, and EUR/USD represents an estimated 30% of all trades. Other major euro crosses include EUR/JPY at 4%, EUR/GBP at 3% and EUR/AUD at 2%. The European Central Bank sets policy across the 20-country euro area, aiming for 2% inflation and meeting eight times a year.
Shifting Risk Sentiment And Central Bank Divergence Support The Euro
We see the Euro gaining strength against the US Dollar, driven by a clear shift in global risk sentiment and central bank expectations. Signs of de-escalating trade tensions between the US and China are making investors more comfortable moving away from the safety of the US Dollar. This environment is generally favorable for riskier assets, including the Euro.
The economic data from the US supports this view, with the latest Consumer Price Index for April showing inflation cooling to 2.9%, just below forecasts. This, combined with a recent softening in the jobs market, strengthens our belief that the Federal Reserve will be forced to consider interest rate cuts before the end of the year. Markets are now pricing in a greater than 70% chance of a Fed cut by September.
Meanwhile, the picture in the Eurozone is quite different, where inflation remains more persistent, with the latest HICP data holding at 2.6%. This stickiness means the European Central Bank is likely to maintain its current interest rate policy for longer than the Fed. This growing divergence in monetary policy is a powerful driver for a stronger Euro relative to the Dollar.
Positioning For EUR/USD Upside Amid Policy Divergence
In the coming weeks, we will be positioning for a continued rise in the EUR/USD pair. We find buying call options on the Euro to be an effective strategy to capitalize on this expected upward trend while managing downside risk. This allows us to benefit from the anticipated monetary policy divergence.
Looking back, we have seen similar patterns, where a Fed easing cycle that precedes the ECB’s has led to significant and sustained EUR/USD strength. The current setup, with improving European business sentiment surveys from Germany and France, further reinforces our conviction in this trade.
