The EUR/USD Paradox: A Strong Euro in a Weak Economy
The surge is fueled by a mix of diverging central bank policies—with the European Central Bank (ECB) holding steady while the Federal Reserve (Fed) leaning dovish—and global tensions that are pushing gold prices higher and rattling markets.
Traders currently price in only a 41% chance of a single 25-basis point (bps) rate cut by the ECB before the end of the year, while the Fed is widely expected to lower its benchmark rate by half a percentage point over the same period. Interestingly, the euro's ostensible strength is evident not only in EUR/USD. Other pairs—notably, EUR/GBP and EUR/JPY—have been gaining ground too, even as Europe's economic backdrop is far from being rosy: sluggish GDP growth, heavy debt loads, and a rising tide of geopolitical risks.
Normally, these are the kind of conditions that send investors scrambling for the U.S. dollar. But not this time. The euro's recent rally has less to do with confidence in Europe—and more to do with growing doubts about the dollar. Kar Yong Ang, a financial market analyst, explains the reasons for the rally and shares his insights on what to expect next.
1. Dollar Weakness Has Overpowered All
From its latest peak in January 2025, the U.S. Dollar Index (DXY) has dropped by more than 11%—one of its worst starts in decades, on par with the slumps seen back in 1986 and 1989[1]. As inflation cools, investors are betting on rate cuts, which pulls down yields on U.S. Treasuries. Add to that a rising divergence in monetary policy expectations and the recent trade tariffs drama , and the dollar's usual safe-haven appeal is fading—even with plenty of geopolitical noise still in the background.
2. Shifting Fed–ECB Divergence
While the ECB has signalled one or two cuts by year-end, markets now price in a less aggressive path[2]. By contrast, the Fed seems to be taking a dovish stance, with interest rates swaps market data factoring in a rate cut in September and a second by December. That widening differential in forward rates has supported EUR/USD, even though eurozone growth has been far more fragile.
3. Trump Tariff Risk and Asymmetric Sentiment
The U.S. trade policy uncertainty, particularly the threat of renewed tariffs, has weighed more heavily on the USD sentiment than it has on eurozone exposure. Markets view these tariffs as potentially inflationary and detrimental to U.S. economic growth. Speculative positioning data confirms record bearish sentiment on the dollar—fund managers are notably underweight USD for the first time in two decades[3].
4. Eurozone's Political and Fiscal Pivot
In a major shift, Germany has finally loosened its purse strings, choosing to borrow and invest—a dramatic break from its long-held stance on fiscal restraint[4]. That move has sparked hopes of a broader, investment-driven recovery across the eurozone. At the same time, ECB President Christine Lagarde has been careful not to fuel speculation about deep rate cuts, helping to steady market expectations and project a sense of monetary calm—at least for now.
5. Unwinding of Safe-Haven Flows
Traditionally, geopolitical stress lifts the USD via flight to safety. But this cycle is different. Investors are increasingly favouring gold, the Swiss franc, and the yen as defensive assets. The euro has benefited indirectly, especially as U.S. equity outflows reduce demand for dollar-denominated assets. In April, when Trump delayed tariff plans, safe-haven inflows into USD unwound further, fuelling euro gains[5].
6. Cooling U.S. Inflation
May and June CPI reports confirmed disinflation is taking hold in the U.S., reducing the urgency for Fed tightening[6][7]. This added another leg to the euro's rally as rate differentials widened.
Although many factors end up in the EUR's favour, a lot of them are likely to remain temporary. At the same time, the following structural issues may potentially exert a downward pressure in the long-term.
Fundamentals Remain Misaligned. The eurozone economy is not booming. The IMF projects just 0.9% growth for the euro area in 2025, with Germany, France, and Italy struggling to regain momentum[8]. The ECB's Financial Stability Review flags worsening credit conditions, weak private investment, and deteriorating balance sheets[9]. None of these support sustained euro appreciation.
Stronger Euro Risks Undermining Exports. Eurozone exporters—particularly in machinery, chemicals, and autos—already face compressed margins due to rising input costs and global protectionism. A stronger euro worsens this, making goods less competitive in global markets. The eurozone's current account surplus, long a structural support for EUR, is shrinking—raising questions about long-term sustainability. According to the latest ECB report, the eurozone's seasonally adjusted current account surplus shrank to just 19.8 billion euros in April from 50.9 billion euros in March[10].
Political Risk Premium May Reassert. Political tensions are bubbling under the surface—fragile coalitions in Germany, budget battles in France, and a fresh wave of anti-EU sentiment in Italy and the Netherlands. If any of these flare up, or if the ECB turns more dovish to cushion a softening labour market, the euro's recent gains could unravel just as quickly as they came.
Alongside these factors, the pair is technically overextended. 'EURUSD has already retraced precisely 78.6% of its major bearish trend which began in January 2021 and ended in September', explains Kar Yong Ang. 'Now a very strong resistance area lies ahead defined by the 1.18000-1.20000 levels. It will not be an easy task to pass through it. Furthermore, we see bearish RSI [Relative Strength Index] divergence on a daily chart, so I will not be surprised to see a solid pullback towards the 1.13000 level.'
The euro's rise says more about the dollar's vulnerability than Europe's progress. Widening rate differentials and U.S. trade policy uncertainty have pushed EUR/USD higher. But scratch the surface, and you'll find shaky fundamentals and warning signs on the charts.
Unless the dollar keeps weakening, don't be surprised if the tide turns. For now, the euro's strength might just be a reflection in the dollar's rear-view mirror—not a signal of real economic momentum in the eurozone.
https://www.reuters.com/markets/currencies/dollar-exit-could-be-crowded-some-time-2025-06-18/ ↑
https://www.reuters.com/markets/europe/ecb-should-neither-signal-pause-nor-rate-cut-nagel-says-2025-06-16/ ↑
https://www.barrons.com/articles/fund-managers-upbeat-bofa-d8770424 ↑
https://www.business-standard.com/world-news/euro-rallies-as-germany-s-historic-debt-overhaul-boosts-growth-outlook-125030500730_1.html ↑
https://uk.finance.yahoo.com/news/safe-havens-rebound-sino-us-021432589.html ↑
https://energynews.oedigital.com/crude-oil/2025/05/13/dollar-drops-as-global-stocks-rise-after-us-inflation-data ↑
https://www.hellenicshippingnews.com/us-dollar-sinks-as-inflation-cools-euro-surges/ ↑
https://www.imf.org/en/Blogs/Articles/2025/04/22/the-global-economy-enters-a-new-era ↑
https://www.ecb.europa.eu/press/financial-stability-publications/fsr/html/ecb.fsr202505~0cde5244f6.en.html ↑
https://data.ecb.europa.eu/data/data-categories/balance-payments-and-other-external-statistics/balance-payments-and-international-investment-position/current-account/total-current-account-and-subaccounts ↑
This article was originally posted on FX Empire
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