During Thursday's Asian trading session, the euro traded with a slight uptick against the dollar, hovering around the 1.1595 mark. The pair remains entrenched in its lowest territory since August 20. The elevated probability of a Federal Reserve rate hike in September, now at 62.3% after hawkish remarks from the Fed chair—up from below 40% beforehand—combined with escalating tensions in the Middle East, continues to cap the euro's potential for gains. Meanwhile, European Central Bank Governing Council member François Villeroy de Galhau has indicated that further rate increases may be necessary if inflation veers in an "unfavorable direction," while Bundesbank President Joachim Nagel notes that market pricing for a September hike exceeds 95%. Although the eurozone's economic resilience offers some support, concerns over terms of trade, triggered by a rebound in oil prices, are eroding sentiment towards the single currency.

Fed's Hawkish Stance and Geopolitical Risks Weigh on Euro

The euro has found a degree of stability near the 1.1580 level against the dollar, yet its upside remains constrained. The distinctly hawkish comments from Federal Reserve Chair Kevin Warsh have significantly reshaped market expectations, catapulting the probability of a September rate increase from under 40% to 62.3% and reinforcing the dollar's interest rate advantage. Concurrently, former President Trump's remarks that any strike on Iran would likely be "brief," while reiterating the strategic necessity of controlling the Strait of Hormuz, coupled with Tehran's warnings of a "new strategy," have intensified the geopolitical atmosphere. The fluctuating situation in the Middle East is providing the dollar with consistent safe-haven buying, further cementing its relative strength. With expectations of Fed tightening and geopolitical risks converging, the dollar enjoys dual support, leaving the euro under sustained pressure. Traders broadly believe that unless US economic data deteriorates markedly or geopolitical tensions cool rapidly, the euro is unlikely to break through resistance levels decisively in the short term, with the market leaning towards a cautious stance.

ECB Rate Expectations Offer Support, Yet Oil Price Rebound Stirs Trade Concerns

Hawkish voices within the European Central Bank continue to provide structural support for the euro. Villeroy de Galhau explicitly stated that further rate hikes would be required if inflation "moves in the wrong direction," and Nagel pointed out that market pricing for a September hike has exceeded 95%, reflecting the Governing Council's vigilance regarding inflation risks. These statements help to solidify the euro's interest rate expectations. However, Scotiabank cautions that the euro's recent weakness has almost exactly coincided with the energy market's rebound—"the new deterioration seems to be happening alongside the recovery in oil prices, raising concerns about the terms of trade for the eurozone as a major energy importer." The rise in oil prices directly increases import costs, weakening the eurozone's terms of trade and partially offsetting the support derived from the interest rate differential. This shift in commodity dynamics is becoming a potential drag on the euro. Attention now turns to the upcoming US ISM services PMI and Friday's non-farm payrolls data, which will be crucial for gauging the direction of Fed policy and the evolution of risk sentiment.

Institutional Outlook

Despite the short-term pressures exerted by the oil price rebound and Fed expectations, major financial institutions maintain a view that the euro will strengthen in the medium term. MUFG, in its September 2026 FX monthly outlook, projects the euro will reach 1.1500 against the dollar in Q3 2026, rebound to 1.1800 in Q4, and advance further to 1.2000 in the first two quarters of 2027. The bank suggests that while the dollar may demonstrate relative strength in the near term, potentially pushing the euro slightly lower due to Fed rate hike expectations and geopolitical support for the dollar, it remains bullish on the euro in the medium term. MUFG believes a September rate hike by the ECB is almost certain, with a subsequently hawkish policy path, whereas the Fed has limited room for hikes, making the interest rate differential progressively favorable to the euro. Additionally, the US fiscal deficit and treasury supply pressures could diminish the dollar's appeal. Political uncertainties, including German state elections and the French presidential race, persist, but the overall fundamentals and policy differential support the euro's upward trajectory in the medium term. MUFG cautions that energy price volatility could disrupt short-term trends and advises monitoring the pricing adjustments following the two major central banks' decisions in September.

ING maintains its euro-dollar target of around 1.18 for year-end, with a near-term projection of roughly 1.17 for the end of September and a 12-month outlook of 1.20. The bank argues that the ECB's September hike is fully priced in and provides structural support for the euro, but the recent energy price rebound, which raises terms of trade concerns, limits its upside potential in the near term. Strategists point out that the dollar is not yet ready for sustained significant weakness, with elevated energy prices and longer-dated Treasury yields still offering it support, making a substantial breakout in EUR/USD difficult in the short run. If the Fed ultimately refrains from hiking or delivers a smaller increase than anticipated, the euro could gradually appreciate.

At 12:23 Beijing time, the euro was trading at 1.1595/96 against the dollar.