Euro Set for Deeper Drop as Markets See More ECB Rate Cuts
Traders are scaling back bets for a deeper divergence between European and U.S. interest rates, putting the euro on a clear path to further weakness.
Weak inflation data from Germany and France on Friday bolstered the case that the European Central Bank will continue monetary easing this year after cutting rates on Thursday. Meanwhile, the Federal Reserve kept interest rates on hold on Wednesday and signaled a pause, ensuring the dollar remains a much more attractive currency.
The big question now is how deep the euro’s decline will be, with many forecasters betting that parity with the dollar is possible in the coming months. Traders are now fully pricing in three more ECB cuts before the end of the year and are pricing in a nearly 30% chance of a fourth. The central bank may have to go further if U.S. President Donald Trump follows through on his promise to impose punitive trade tariffs. “This week’s central bank meetings confirmed the policy divergence,” said Matthew Landon, global market strategist at J.P. Morgan Private Bank. Tariffs could widen the gap further, “bringing the possibility of euro-dollar parity back into contention,” he added.
Data published Friday showed a drop in German regional inflation and an unexpectedly steady reading of French prices. That followed Thursday’s release that euro-zone growth stalled in the fourth quarter. At the same time, solid U.S. growth added to the argument that the Fed will hold off on easing.
After slumping to a two-year low of $1.0178 earlier this month, the euro has recovered on relief that Trump did not impose tariffs on Europe in his first few days in office. The currency fell to $1.0365 on Friday, while bunds extended their rally after Thursday’s interest-rate decision. The two-year yield fell 8 basis points to 2.13%, its lowest in four weeks. Options traders are bearish on the euro across all maturities, while the premium to hedge against near-term weakness has doubled since Wednesday. Meanwhile, total trades targeting the euro fell to parity with the dollar, which doubled in January from the previous month, according to DTCC.
Source: Bloomberg
