The euro commences the concluding week of September at a disadvantage. EUR/USD is currently at 1.1377, reflecting a decline of 0.13% from the previous session. Throughout the Asian and European mornings, the pair has fluctuated between a one-month low of 1.1360 and the 1.1400 threshold. The pair has not maintained a position above 1.1400 since last Wednesday, and each rally attempt this morning has diminished below that level. The damage accumulates over time rather than occurring abruptly. The EUR/USD currency pair has experienced a decline of 0.80% in the last seven sessions, 1.80% over the past month, and 3.01% over the preceding twelve months. The pair reached a peak of 1.1490 on September 21, marking the week’s high, before experiencing a decline over four consecutive sessions, ultimately falling to a low of 1.1368 on September 24. Monday’s trade is once again probing that low, with the one-month floor positioned at 1.1360, a mere 17 pips beneath the prevailing price. The euro currently stands at its lowest point since late July. The daily reference fixings indicate the trajectory. The pair stood at 1.1541 on September 15, dropped to 1.1463 on September 16, the day the Federal Reserve hiked, recovered to 1.1486 by September 19, then gave it all back: 1.1464 on September 21, 1.1448 on September 22, 1.1384 on September 23, and 1.1381 on September 24. That represents a decline of 160 pips over the course of two weeks. The catalyst for the pressure observed on Monday is the identical shock affecting all asset classes. President Trump rejected Iran’s proposal to reopen the Strait of Hormuz. Brent crude jumped to $106.55, the 10-year Treasury yield climbed to 5.22%, and fed funds futures now price a 70.3% probability of an October Fed hike. The dollar index stands at 101.09, exhibiting firmness in its position.
The thesis for this forecast is that the euro is concurrently losing the policy race and the energy war. The European Central Bank has implemented two rate hikes since the onset of the Middle East conflict; however, the Federal Reserve is tightening at a more accelerated pace. Consequently, the market is anticipating a greater number of Fed rate increases compared to those of the ECB by year-end. Every increase in oil prices exacerbates that disparity, as the eurozone relies on energy imports while the United States is a producer. Rate differentials favour the dollar, and terms of trade favour the dollar. Until one of those two forces reverses, the path of least resistance for EUR/USD suggests a movement toward 1.1300. The week ahead presents critical information from both sides of the Atlantic. The eurozone’s flash September inflation estimate is set to be released on Wednesday, coinciding with the US PCE report on the same morning. Friday brings the release of US payroll data. Those three releases will determine if 1.1360 remains intact or is breached. Currency pairs are influenced by relative interest rates, with the disparity between the Federal Reserve and the European Central Bank serving as the primary factor for the EUR/USD trading near a two-month low. The Fed raised rates by 25 basis points on September 16, elevating its target range to 3.75%–4.00%, and indicated that additional increases may be forthcoming. The ECB raised its three key rates by 25 basis points six days earlier, on September 10, taking the deposit facility rate to 2.50%, the main refinancing rate to 2.65% and the marginal lending rate to 2.90%, effective September 16. Measured from the upper limit of the Federal Reserve’s range to the European Central Bank’s deposit rate, the policy gap is currently at 150 basis points.
Both central banks are increasing interest rates in response to an energy shock, yet their rate hikes are not occurring at an identical pace. The ECB implemented its initial rate increase since 2023 in June, took a pause in July, and proceeded with another hike in September. The minutes from July emphasised that the pause did not signify the conclusion of the tightening cycle. Money markets currently anticipate at least one additional 25-basis-point increase from the ECB by the end of the year, with a 40% likelihood of a subsequent hike. The Federal Reserve is accelerating its actions. Fed funds futures indicate a 70.3% likelihood of a rate hike at the meeting on October 28, an increase from 64.2% in the previous session and 57% a week prior. Some traders are anticipating a third increase at the December meeting. If the Fed increases rates in October and December while the ECB implements a single adjustment, the policy gap would expand to 175 basis points by the end of the year. The long end conveys the same narrative with greater clarity. The 10-year Treasury yields 5.22%, whereas Germany’s 10-year Bund remains at 3.624%, showing little variation during the session. That represents a 160-basis-point spread favouring dollar assets. The 30-year Treasury yield at 5.51% is currently at its peak since 2004. A global investor selecting between a 10-year Bund and a 10-year Treasury benefits from an additional 160 basis points of yield by opting for the US bond, a yield differential that attracts capital into dollars. Rate differentials alone do not determine exchange rates; however, they do establish the carry. A trader who holds a long position in dollars against euros benefits from the interest rate differential for each day the position remains active. With the spread at 150 basis points on policy rates and 160 on 10-year yields, the expense associated with wagering on a euro rally is considerable.
Short euro positions provide a benefit to the holder, whereas long euro positions incur a cost for the holder. That arithmetic elucidates the challenges the euro has faced in maintaining upward momentum this month. Only a narrowing of the rate gap, through a softer Fed or a more aggressive ECB, can change the carry math. Energy represents a significant factor contributing to the depreciation of EUR/USD, exerting a more pronounced impact on Europe compared to the United States. Brent crude is currently priced at $106.55, reflecting an increase of over 2% from Friday’s settlement of $104.32, following the White House’s dismissal of Iran’s seven-day ceasefire proposal. November WTI experienced an increase of 4.24%, reaching a price of $96.33. Iran has stated that it will maintain its firm stance regarding the conditions for reopening the strait, with mediator discussions anticipated to recommence this week. The Strait of Hormuz was responsible for transporting one-fifth of the global supply of crude oil and liquefied natural gas prior to the onset of the conflict. Brent has increased by over 70% this year and is poised to achieve a third consecutive monthly gain. The conflict between the United States and Iran has now entered its eighth month. The influence of currency fluctuations permeates the terms of trade. The eurozone operates as a net importer of energy resources. Each additional dollar in the price of a barrel escalates the import expenditure for European economies, syphons euros from the region to settle dollar-denominated energy costs, and exacerbates the current account deficit. The United States operates as a net energy producer, thus elevated oil prices enhance its trade balance.
An oil shock represents a redistribution of wealth from nations that import energy to those that export it, placing the euro at a disadvantage in this financial exchange. The inflation data substantiates the prevailing pressure. Eurozone headline inflation rose to 3.3% in August, up from 2.9% in July, marking the highest rate since September 2023. Energy inflation surged to 14.3%, marking its peak since January 2023. Germany’s inflation rate increased to 2.9%, up from the previous 2.8%. Energy prices directly impact European households. German consumer sentiment declined more significantly than anticipated as October approached, with increasing energy costs exerting pressure on income expectations. A consumer burdened by energy bills reduces expenditures on other items, thereby decelerating growth despite the increase in prices. The relationship between oil and EUR/USD exhibits a notable complexity. Declining oil prices represent a structural advantage for the euro via the terms-of-trade mechanism; however, they often lead to a more pronounced downward adjustment of ECB rates compared to the Fed, which exerts pressure on the pair through interest rate differentials. Last week illustrated the prevailing tension: Brent briefly dipped below $100 amid optimism regarding a US-Iran breakthrough, European bond yields declined, and the euro continued its descent to its lowest level since late July. Monday’s move clarifies the situation. Rising oil prices elevate US yields and increase the likelihood of a Federal Reserve rate hike to a greater extent than they influence expectations for the European Central Bank, simultaneously negatively impacting European terms of trade. Both channels indicate a consistent direction.
