EUR/USD rebounded on Friday as the US Dollar retreated, lifting the pair to about 1.1470 after it earlier touched a three-month low of 1.1417. The US Dollar Index eased after Reuters reported Israel and Hezbollah had agreed to a ceasefire, a condition tied to a 60-day MoU reached earlier this week involving Iran. DXY, which measures the greenback against six major currencies, traded near 100.81 after an earlier peak of 101.13, its highest level since May 2025, though EUR/USD remained set for a weekly decline as markets repriced US rates in a more hawkish direction.
The Federal Reserve kept its policy rate unchanged at 3.50%-3.75%, while reiterating that further hikes remain possible as it targets 2% inflation following firmer price pressures linked to higher oil. In Europe, the European Central Bank’s 25 basis-point increase has not translated into sustained euro support, even as the debate over another 25 bps move continues. Attention now turns to preliminary PMI releases in the eurozone and the US next week, alongside the US PCE Price Index.
Short-Term Drivers and Market Positioning
We are viewing Friday’s rebound in EUR/USD as a short-term correction driven by easing geopolitical tensions in the Middle East. This has provided a brief respite for the Euro, but the underlying fundamentals have not changed. Derivative traders should be cautious about this strength, as it may present a better level to re-establish bearish positions.
Monetary Policy Divergence and Tactical Outlook
The Federal Reserve remains more hawkish than the European Central Bank, which is the primary driver for our outlook. With the latest US core PCE data for May 2026 coming in at 3.1%, the Fed has clear justification to keep rates higher for longer. This persistent interest rate differential in favor of the dollar will likely cap any significant EUR/USD rallies.
We see continued weakness in the Eurozone economy, which limits the Euro’s potential even with a hawkish ECB. Recent data showed the flash Eurozone Manufacturing PMI for May 2026 was 48.5, remaining in contractionary territory for the fourth consecutive month. This economic divergence with the US, whose Services PMI was a robust 53.2, reinforces the case for a stronger dollar.
In the coming weeks, we will look to use options to express this view, potentially by selling out-of-the-money call spreads to capitalize on a capped upside. Next week’s preliminary PMI releases and the US PCE data will likely increase volatility, offering tactical opportunities. We believe strategies that profit from range-bound trading or a gradual decline toward the 1.1400 level remain prudent.
