Written by Sruthi Shankar and Alun John
(Reuters) – The euro is trading at its highest level this year against the dollar, emerging as a clear winner from recent turmoil in global currency markets that has destabilized the strong dollar and halted a sustained slide in the Japanese yen.
After a decisive breakout above the symbolic $1.10 level, the euro gained more than 2.5% in August, setting the currency on track for its best month since November.
Traders have begun to focus on the market, having so far been preoccupied with the yen’s sudden rise after the Bank of Japan’s surprise interest rate hike on July 31, and the dollar’s sharp decline as expectations of a U.S. rate cut grow.
After all, history shows that $1.10 is not an easy level to break, and back in April, some analysts speculated that the euro could weaken to parity.
The pound has now become the second-best performing major currency against the dollar this year after the British pound, and is now at its highest trade-weighted level ever, although this is also due to weakness in emerging market currencies.
However, the dollar’s gains, which are expected to be modest going forward, are notable as talk of a Fed rate cut coincides with speculation that further easing by the European Central Bank may be limited by persistent service sector inflation.
“It’s a story of spreads,” said Volkmar Bauer, currency analyst at Commerzbank.
“Inflation is coming down on both sides of the Atlantic, but the Fed is expected to move a little bit more aggressively along the way down, and that narrows the spreads a little bit and makes way for a stronger euro.”
Market prices suggest the European Central Bank, which cut interest rates in June, is likely to deliver at least two more 25 basis point cuts.
By contrast, traders see the Fed cutting rates by 94 basis points over its remaining three meetings this year—three 25-basis-point moves, with a good chance of a bigger one. That’s a change of about 30 basis points from early August; the ECB’s pricing move was much smaller.
The shift came on the heels of weak U.S. labor market data that raised recession fears and rattled stock and bond markets. Markets have since calmed down, but expectations of policy easing remain.
It is certainly not just the euro that strengthened against the dollar in August, but the single currency is the one that presents the least complications for traders looking for a relatively safe bet in the forex market.
The yen is volatile after the massive carry trade unwinds. Sterling’s gains in August were also pared after the UK cut interest rates and eased political risks in France, which had hurt the euro in June.
“We have seen some de-risking of the euro such as the French elections,” said Salman Ahmed, head of macro asset allocation and global strategy at Fidelity International.
“It’s now the cleanest central bank story.”
It gets harder
But from here, the euro may struggle to make further progress.
Analysts said the pound was at the top of recent trading ranges and there was less room for spreads to shift in its favour.
Commerzbank expects the euro to be at $1.11 by the end of the year, unchanged from current levels. ING sees the euro at $1.12 in a month’s time before falling to $1.10, and Bank of America sees it at $1.12 by the end of the year.
“My view since Q2 2023 has been to play the trading range. Buy the euro at $1.05 and sell when it moves above $1.10,” said Matthew Savary, chief European investment strategist at BCA Research.
For some, this may be the end of the gains.
“These are the strongest euro levels you should expect between now and the end of the year,” said Jay Steer, head of developed markets strategy at Amundi Investment Institute, who believes the case for further cuts by the ECB was more compelling than that of the US Federal Reserve.
The recent economic recovery in the eurozone is showing signs of slowing, while a gauge of German investor sentiment recorded its sharpest decline in two years in August.
In contrast, the next round of U.S. jobs data may show that the weak July report was just a glitch caused by Hurricane Beryl.
Another complicating factor in this mix is the US presidential election scheduled for November 5.
While there are many moving parts, analysts said Republican nominee Donald Trump’s policies of higher tariffs and lower taxes are likely to cause inflation to rise, which means tighter Fed policy and a stronger dollar.
Jane Foley, head of currency strategy at Rabobank, noted that the euro’s recent rise came as his Democratic rival, US Vice President Kamala Harris, made gains in the polls.
“What could really push the EUR/USD above $1.10 and keep it there is a Harris win and a slowing US economy,” she said.