- The euro has surged thanks to growing expectations of U.S. Fed rate cuts, declining Treasury yields, and the ECB's cautious monetary policy guidance
- Overbought momentum indicators, unexpectedly high U.S. inflation, or renewed Eurozone growth worries could trigger profit-taking and push rates lower
- Should Eurozone growth slow, the ECB might shift to an easing policy. This would eliminate the rate-differential support that's currently boosting the euro
The euro’s been gaining ground on the dollar. After climbing 0.95% in July, the EUR/USD pair added another 1.5% in August. Just yesterday, it broke past the 1.1580 resistance, ending the day up 0.88%.
This upward trend points to a change in forex market sentiment. Traders watching this cross can’t help but wonder what’s fueling the euro’s rally and what obstacles might appear.
Where Is the Euro Getting Its Fuel?
The euro’s climb mostly comes from the European Central Bank (ECB) and Federal Reserve’s diverging monetary policies. Eurozone inflation, as measured by the Harmonized Index of Consumer Prices (HICP), hit 2.9%.
So, market participants expect an ECB interest rate hike at their September 10 meeting. Controlling inflation is the ECB’s main goal, a job made tougher by rising energy prices from Middle East geopolitical events.
Currently, markets are pricing in a 90% chance the ECB will raise rates by 25 basis points in September, pushing the rate to 2.50%. What’s more, better economic survey data from the Eurozone, like a stronger German ZEW index, hints at more stable regional conditions.
On the other hand, recent weaker U.S. economic data has lowered expectations for further Federal Reserve rate increases, signaling a weaker dollar. The July non-farm payrolls report missed forecasts, retail sales dropped, and inflation numbers came in lower than expected.
Consequently, the odds of a September Fed rate hike have fallen, with markets now giving about a 65% chance the Fed will hold rates steady.
Lower US Treasury yields are also weakening the dollar, partly because the Treasury Department announced it’ll buy more longer-term bonds starting in September.
EUR/USD Has Room to Run, But Watch the Data
Technical analysis suggests the EUR/USD could climb, targeting 1.1750-1.1800. If prices hold above 1.1700, buyers might step in, driving the rate toward 1.1725 or even higher.
The short-term outlook looks good for the next few weeks, as long as support levels at 1.1600-1.1635 hold. But the quick price jump suggests the market might be getting overbought. That could mean some consolidation or small pullbacks.
Potential Setbacks Ahead
A few things could slow the euro’s climb. For instance, if US inflation picks up again, or if employment and growth numbers come in stronger than expected, it might reignite expectations of Fed rate hikes. That would likely boost the dollar.
Another factor is ongoing geopolitical instability, particularly around US-Iran relations, along with high oil prices. These usually send investors to the dollar as a safe haven.
Over in Europe, weaker economic growth surveys or slowing inflation might dampen expectations for European Central Bank rate hikes. A big jump in longer-term US Treasury yields could also shrink the interest rate gap that’s been good for the euro.
Softer US data reduced Fed hike odds while sticky euro-area inflation boosted expectations of an ECB rate increase in September.
A rebound in US economic data or escalating Middle East tensions that revive dollar demand and Fed-tightening expectations.
 Yes. If eurozone growth weakens, the ECB could pivot toward easing, removing the rate-differential support currently favoring the euro