As market expectations deepen regarding the divergent monetary policy paths of the European Central Bank and the Federal Reserve, traders are renewing bets that EUR/USD will rise to the key psychological level of 1.20.
Weak U.S. non-farm payroll data last week has intensified market expectations for aggressive Fed rate cuts, further weakening the dollar. Meanwhile, the ECB has paused its easing cycle, with money markets seeing only a one-third probability of a rate cut before December.
On Tuesday, EUR/USD gained as much as 0.1% to 1.1780, reaching its highest level since July 24th, before paring some gains to trade at 1.173. The euro largely ignored political risks as French Prime Minister Barnier lost a parliamentary confidence vote.
George Saravelos, Head of Global FX Research at Deutsche Bank, believes that deteriorating cyclical support for the dollar and a significant narrowing of U.S.-European interest rate differentials have returned EUR/USD fair value to the 1.18-1.20 range. Technical indicators are also turning bullish, with monthly charts forming a bullish engulfing pattern.
**Monetary Policy Divergence Driving Euro Rally**
Activity in options markets clearly reflects investor bullish sentiment. Data shows that so-called "risk reversal indicators" display a bullish bias toward the euro across all maturities. According to Depository Trust & Clearing Corporation (DTCC) data, one-third of bullish bets since last Friday have targeted a euro breakout above 1.20.
Thomas Bureau, Co-Head of FX Options at Société Générale, states that the euro's next key resistance level is $1.18. He believes that once this level is breached, it could trigger significant stop-loss orders, accelerating the euro's upward momentum.
U.S. macroeconomic data is the key driver behind this round of market expectations. Following last week's non-farm payroll data, a potential negative revision to U.S. employment data benchmarks due later today could provide further support for the euro. Market expectations for decisive Fed action are heating up.
George Saravelos adds:
"It's clear that further Fed rate cuts from current levels will increase foreign investors' incentive to hedge their dollar assets."
**Limited Political Risk Impact, Technical Indicators Turn Bullish**
Despite political turmoil in France, the euro has shown considerable resilience. On Monday, the euro still gained 0.4% after French Prime Minister Barnier lost the parliamentary confidence vote, while the cost of hedging against euro strength also increased.
Danske Bank analysts wrote that widening French government bond yield spreads might limit the euro's upside potential, but they still consider EUR/USD undervalued. Berenberg Bank Chief Economist Holger Schmieding suggests that while France may face credit rating downgrade risks, given its current account is near balance, the possibility of a full-scale crisis remains unlikely:
"ECB President Lagarde must choose her words carefully this Thursday, neither hinting that the ECB might ultimately bail out unrepentant fiscal sinners, nor taking too harsh a stance that could disturb markets that still maintain confidence in France."
From a technical analysis perspective, multiple indicators are turning favorable for the euro. Monthly charts have formed a so-called "bullish engulfing" pattern, suggesting the euro may retest the 1.1829 high reached in July. In the short term, the market sentiment index known as the "Fear and Greed Indicator" shows euro bulls are in their strongest position in over two months.