Dollar throws boomerang

[Ben Graham]

The euro closes the year on a high note, like a leading runner already looking ahead to the next lap. In 2026, the regional currency will enjoy dual support from both revised upward expectations for eurozone economic growth and the narrowing of the interest rate gap between Europe and the US. According to a Financial Times survey, eurozone GDP is projected to grow by 1.2% in 2026 and 1.4% in 2027. For 2025, the consensus is 1.4%, significantly higher than the 0.9% that the market anticipated at the end of 2024. The acceleration in growth has become a long-awaited wind in the sails and one of the drivers behind the 13.5% rally in EUR/USD this year.

The second argument involves interest rates. The same FT experts expect the ECB's deposit rate to remain at 2% through the end of 2026 and rise to 2.25% in 2027. For the Fed, derivatives are pricing in two rate cuts next year. If the interest rate and yield differential between the US and Germany continues to narrow, the euro may maintain its upward momentum: as the elevation gap decreases, the ascent becomes easier, even if the road is still uphill.

Dynamics of EUR/USD and bond yield spreads

However, risks have not disappeared. Markets tend to interpret pressure from the White House on the Fed as a "bullish" factor for EUR/USD. Yet a bet on a "dovish" FOMC could backfire like a boomerang: attempts to accelerate easing may lead to rising Treasury yields.

The Federal Reserve controls the short end of the yield curve, but expectations of its actions shape bond yields—and thus the cost of servicing government debt. This is why the yield on 10-year securities is so critical in the Treasury's agenda: Scott Besant, upon taking office, discussed the goal of bringing it down to 3% as part of the "3-3-3" strategy. The other two "threes" pertained to oil and US economic growth.

The paradox is that discussions about overly aggressive rate cuts amid a strong economy could push yields not down, but up. Investors may start pricing in the risk of a repeat of the 1970s inflation saga, when, under political pressure, Fed Chairman Arthur Burns accelerated easing, which led to a spike in prices and subsequently a double recession.

The Treasury curve is the nervous system of the market: movements in it affect both the S&P 500 and the dollar. Rising yields increase the cost of capital for companies, compress margins, and can provoke a pullback in stocks—as if the business had its "oxygen price" raised. For the dollar, the effect is the opposite: higher yields enhance the attractiveness of American assets, prompting capital inflows into the US and supporting the USD index. Notably, during Christmas week, the dollar index posted its worst performance since June amid declining bond yields.

Technical analysis

Technically, the daily chart of EUR/USD shows a test of key support at the pivot level of 1.176. If the bears succeed in this endeavor, it will pave the way for short-term sales of the euro against the US dollar. Conversely, a rebound would provide grounds to increase previously established long positions.

The material has been provided by InstaForex Company - www.instaforex.com