Euro Struggles as Dollar Gains Strength

The euro-dollar currency pair is currently under pressure, trading vulnerably near a more-than-a-month low, around 1.0350, as the new trading year begins.

The EUR/USD exchange rate is skating on thin ice, with the dollar retaining its strength at a more than two-year high. The DXY Dollar Index is trading around 108.50 due to growing optimism that the Federal Reserve will implement fewer interest rate cuts this year than previously expected.

In 2024, the Fed reduced its key borrowing rates by 100 basis points (bps), as policymakers expressed greater concern about increased risks to employment compared to inflationary pressures. However, the Fed has indicated that it will pursue fewer interest rate cuts this year, reflecting an optimistic outlook for the U.S. economy.

Additionally, a slowdown in the disinflation trend has prompted officials to opt for a more gradual approach to easing policies.

The latest projections, included in the Fed’s Summary of Economic Projections, suggest that Federal Funds rates are expected to reach 3.9% by the end of 2025, which is an increase from the 3.4% forecast made in September.

According to the CME FedWatch tool, it is almost certain that the central bank will maintain interest rates in the range of 4.25-4.50% during their January meeting.

Looking ahead, the movement of the dollar will likely be influenced by the upcoming U.S. ISM Manufacturing Purchasing Managers Index (PMI) data for December, set to be released on Friday. This PMI is anticipated to decrease slightly to 48.3 from the previous reading of 48.4, indicating a marginal acceleration in the contraction of manufacturing sector activities.

The euro may continue to experience selling pressure, as the European Central Bank (ECB) is expected to keep its steady rate-cut cycle in place until June. This scenario hints at four anticipated interest rate cuts, which would lower the Deposit Facility rate to 2%.

Market experts foresee further easing of policies since price pressures in the Eurozone are expected to stabilize sustainably at the ECB's target of 2%. Moreover, investors are bracing for a significant slump in European exports due to the anticipated rise in import tariffs from the U.S. under the new Trump administration.

In addition, the market is keenly awaiting preliminary German and Eurozone Harmonized Index of Consumer Prices (HICP) data for December, which is set to be released early next week.

This HICP data will play a crucial role in determining whether the ECB will maintain its current pace of interest rate cuts at 25 bps or shift to a more aggressive approach of 50 bps.

euro, dollar, interest