The euro has reached a new high, a level not seen since October 2021. European leaders’ plans to boost NATO spending may also lead to more relaxed fiscal rules in the eurozone. The US dollar is weakening, largely due to easing tensions in the Iran-Israel conflict. The euro’s increase is linked to higher German government spending and ongoing trade disputes.

US Inflation Factors

US inflation and potential rate cuts are impacting the dollar’s short-term strength. The European Central Bank (ECB) is currently inactive, while Morgan Stanley expects notable rate cuts by the Federal Reserve next year. Upcoming US inflation data, particularly the PCE report, is crucial in this financial landscape. If tariffs do not sharply increase prices, this may trigger dollar-weakening rate cuts. Markets are expecting around 104 basis points of easing next year, but this could change. On the euro chart, there’s not much resistance until 1.20 or 1.22. The recent positive trend suggests a promising outlook. We’ve seen a strong rise in the euro, breaking through barriers from early Q4 of 2021. This surge occurs as market sentiment shifts away from defensive investments towards growth-sensitive assets. The recent push by eurozone countries to increase NATO contributions might be instilling investor confidence that public finances will be geared towards long-term support, easing strict fiscal rules. This change removes obstacles to euro appreciation. In contrast, the dollar is facing pressure, largely due to improved conditions in the Middle East. Such geopolitical relief often boosts carry trades and reduces demand for the dollar as a safe haven. However, macro data also plays a significant role. Recent inflation figures from Washington show a drifting trend rather than a stable one. Traders are increasingly betting on rate cuts from the Federal Reserve, with current expectations suggesting over 100 basis points will be removed in 2025, particularly in the spring.

Interest Rate Outlook

Gorman’s team expects a significant drop in US interest rates, enhancing the euro’s relative strength. If this easing occurs—especially without new tariffs that could raise inflation—it may create room for more short dollar positions. However, market sentiment can change swiftly; any decline in core inflation or payroll numbers could slow the support for this outlook. Technically, the euro’s chart is clearer than it has been for a while. There are no strong resistance levels until around 1.20 or beyond. Momentum indicators look solid, and volume patterns indicate continuing strength. We see unique opportunities in rate-sensitive derivatives, especially where the euro’s strength is undervalued compared to future policy differences. For those invested along the interest rate curve, watching how implied volatility shifts in options markets—especially in euro-dollar rate spreads—could be valuable. If US markets adopt a dovish stance without a change in Frankfurt, this gap could be leveraged using calendar spreads or delta-neutral strategies. Additionally, traders are not fully utilizing shorter-term euro-denominated interest rate instruments. There’s potential to gain positive carry without committing to long-term positions. However, caution is needed; overnight indexed swaps already reflect optimism about policy direction, and any difference between expected and actual central bank actions could shift the dynamics quickly. The euro’s trajectory looks clearer than it has in months, but risks remain. Durable goods orders and consumption forecasts in the US will have significant market impacts, and each release should be evaluated against real yield differences. As always, unexpected data will drive adjustments. Create your live VT Markets account and start trading now.

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