The EUR/USD pair fluctuated within the range of 1.1375 to 1.1385 on Thursday, marking a continuation of its decline for a third consecutive session and reaching its lowest point since July 28 during the Asian trading hours. The pair has now declined in seven of the past nine sessions, with the euro depreciating by 2.53% against the dollar over the past month. Over the course of the past year, the single currency has experienced a decline of 2.42%. The damage accumulated over a span of three days. On Tuesday, the euro experienced a decline of 0.15%. On Wednesday, it opened at 1.1446, reached a peak of 1.1450, and subsequently declined to 1.1425, marking its lowest point since July 29, prior to the U.S. PMI release which propelled it below the 1.1400 threshold. The ECB’s reference rate, established at 14:15 on Wednesday, was recorded at 1.1411, as per the ECB Data Portal. By Thursday morning in Europe, the pair had fallen below 1.1390 and was hovering around the 1.1380 level. The driver does not represent a challenge specific to Europe. Recent data from the Eurozone has demonstrated notable strength. The primary influence is the U.S. bond market. The 10-year Treasury yield reached 5.15% on Thursday, marking its highest level since July 2007, while the 30-year yield climbed to 5.446%, a peak last observed in June 2004. The U.S. Dollar Index ascended to 100.80, marking its peak since July 30. When U.S. yields surge due to hawkish Fed repricing, the dollar attracts capital from all major currencies, with the euro, being the most liquid counterpart, capturing the largest portion of the flow.
The pair’s short-term momentum has attained an extreme level. The daily Relative Strength Index has decreased to 25.47, indicating a significant position within oversold territory. That reading does not indicate a reversal by itself; however, it suggests that the rate of decline will decelerate, making a corrective bounce increasingly probable prior to the subsequent downward movement. This forecast is predicated on a singular thesis: the EUR/USD exchange rate is influenced by the transatlantic interest rate differential, which is expanding from the U.S. side at a pace that exceeds the European Central Bank’s ability to mitigate it. The ECB deposit rate is currently at 2.50%, while the Fed operates within a range of 3.75% to 4.00%. Market expectations indicate a greater likelihood of further tightening from the Fed compared to the ECB. As U.S. yields continue to rise, robust economic data from Europe is insufficient to support the euro. The 1.1353 July low is pivotal in determining whether the current decline will halt and lead to a rebound toward 1.1450 or if it will continue to deteriorate toward the 1.1200 region. All elements in this analysis, including the eurozone’s highest PMI in over three years and the U.S. durable goods data released on Friday, contribute to that singular rate-differential equation. The essence of the EUR/USD narrative lies in the divergence between the two policy rates. The ECB’s deposit rate is currently at 2.50% following the hike on September 10, whereas the Fed’s target range is positioned between 3.75% and 4.00% after its increase on September 16. That results in a differential of 125 to 150 basis points favouring the dollar at the short end.
Both central banks are tightening, making the direction of the gap the critical variable. The ECB has implemented two rate hikes in 2026: first in June, raising the deposit rate to 2.25% effective June 17, as per the ECB’s June decision, and subsequently in September to 2.50%, following a pause in July. The Fed made its initial move of the cycle on September 16, marking its first hike in over three years, with 16 out of 18 policymakers forecasting at least one additional increase before the end of the year. Market pricing currently suggests an inclination for the Federal Reserve to take additional actions. Fed funds futures indicate a 75.3% likelihood of an increase in October and a 58.6% probability of an additional hike in December. Some market pricing indicates the possibility of three additional quarter-point adjustments by the Federal Reserve by mid-2027. On the European side, money markets assign a 60% probability that the ECB will raise its deposit rate to 2.75% during the meeting on 29 October. Those probabilities translate directly into the direction of the pair. If both central banks proceed with their next actions, the differential will remain within the range of 125 to 150 basis points. If the Fed raises rates in October while the ECB holds off until December, the differential could expand to between 150 and 175 basis points for a duration of six weeks. If the Fed increases rates twice more and the ECB once, the disparity will become a permanent fixture. Every scenario in which the Fed outpaces the ECB suggests a decline in EUR/USD.
The long end holds greater significance than the front end this week. The U.S. 10-year yield experienced a notable increase of 15 basis points on Wednesday, rising from 4.96% to 5.11%, and further extended to 5.15% on Thursday. That action expanded the transatlantic 10-year spread in just one session beyond what European bond markets were able to counterbalance. Capital flows are influenced by yield, and a U.S. government bond offering over 5% for a decade serves as an attractive destination for global savings, notably from Europe. The gap elucidates the reason behind the euro’s inability to capitalise on the ECB’s September hike. The EUR/USD exchange rate fell beneath 1.1600 following the ECB announcement on September 10 and subsequently stabilised around 1.1610, reflecting that the interest rate increase was fully anticipated by the market. Since then, the pair has experienced a decline of over 230 pips as the Federal Reserve’s hawkish stance overshadowed the European Central Bank’s actions. The composition of the U.S. bond selloff elucidates the dynamics propelling the dollar’s rally.
According to Treasury’s daily real yield curve, the 10-year real yield increased from 2.63% to 2.76% on Wednesday. That accounts for 13 of the 15 basis points added to the nominal 10-year. Implied inflation compensation increased by 2 basis points, rising from 2.33% to 2.35%. That division is significant for currencies. When nominal yields increase due to concerns about inflation, the currency may depreciate, as inflation diminishes purchasing power. When nominal yields rise due to an increase in real yields, the currency appreciates, as investors receive a greater inflation-adjusted return for holding it. This week’s move represents the second type, characterised as the most dollar-positive combination achievable. The catalyst was the growth of the U.S. economy. The S&P Global composite PMI for September increased to 58.4 from 56.0, with services at 58.7 and manufacturing at 57.0, marking the most robust expansion in the survey since July 2021. Job creation in the survey accelerated to its highest rate since June 2022. On Thursday, weekly jobless claims decreased to 197,000, contrasting with a forecast of 201,000, while new home sales surged by 6.4% to an annual rate of 684,000. Each print reinforced the argument that the U.S. economy is capable of sustaining higher real rates.
The lacklustre performance of the Treasury auction contributed to the prevailing pressure. A soft sale of five-year notes on Wednesday resulted in an upward movement in yields across the curve, with both the U.S. 5-year and 10-year yields surpassing the 5% mark. Yield spreads between the U.S. and the rest of the world have consistently widened since the Fed’s hawkish hike, with this trend accelerating in the past week. For EUR/USD, the real-yield dashboard serves as the most effective instrument. A 10-year real yield retreating below 2.65% would alleviate the pressure on capital and provide the euro with the opportunity to rebound toward 1.1450. A real yield extending toward 2.85% to 2.90% would indicate a prolonged period of restrictive U.S. policy, and in that context, the July low at 1.1353 is improbable to remain intact. The mechanism extends beyond mere yield. European pension funds, insurers, and asset managers maintain substantial portfolios of U.S. bonds. When U.S. real yields increase, those institutions encounter a decision: to augment their dollar exposure for the additional return or to hedge against currency risk. As the rate gap widens, hedging costs increase, leading to a greater portion of the flow remaining unhedged, which results in an increased demand for dollars. That structural demand contributes to the ongoing decline of the euro, even in the face of robust European data releases.
