The Dollar Takes the Initiative

[Ben Graham]

As the saying goes, "man proposes, but God disposes." Expectations often do not align with reality. It was previously thought that Donald Trump's extensive tariffs would significantly slow economic growth in the Eurozone. However, the currency bloc's economy has shown remarkable resilience. As a result, growth forecasts are being raised, which plays in favor of EUR/USD. On the other hand, markets are driven by expectations, and for the euro, things are not as good as one might assume.

The European Commission has recently upgraded its GDP estimates for 2025, following similar moves from the International Monetary Fund and the European Central Bank. The Brussels forecasts appear to be more optimistic. This year, a 1.3% GDP expansion is expected, followed by 1.2% next year. Previous estimates were 0.9% and 1.4%.

Dynamics of European Economic Forecasts

A stronger 2025 and a weaker 2026 is the sentiment from authoritative organizations. The ECB believes that the Eurozone's issues are tied to ongoing high uncertainty, elevated effective tariff rates, and a strong euro. The European Commission cites significant government spending, robust domestic demand, and a strong labor market as drivers of economic growth.

Such forecasts indicate that the upward trend in EUR/USD will likely remain intact. However, the potential for a rally will be limited. It is unlikely that we will see the euro rise to $1.25 and above on a sustainable basis in 2026. If such a level is reached, it will likely be only temporary. However, as with 2025, the ECB, IMF, and European Commission could be mistaken. The potential of the currency bloc should not be underestimated. In fact, anything is possible.

However, in any currency pair, there are always two currencies involved. While the euro strengthens due to the improving economy in the Eurozone, the dollar rises from a reevaluation of investors' views on the fate of the federal funds rate. The USD index responds sensitively to the dynamics of the yield differential between U.S. Treasury bonds and those of G10 countries.

Dynamics of the U.S. Dollar and Bond Yield Differential

The ECB, Bank of Japan, Reserve Bank of Australia, and Swiss National Bank are likely to maintain their rates. The Bank of England, if it does cut rates, will likely do so slowly. Thus, the fate of the greenback largely rests in the hands of the Federal Reserve.

Nordea forecasts that the federal funds rate will fall to 3.75% by the end of the cycle, rather than the market's expected 3.25%. If this is the case, sellers in the major currency pair will face strong resistance, leading to a tendency for medium-term consolidation.

Technically, on the daily chart, EUR/USD is experiencing a drop below fair value and a reversal from the inside bar. The bears have taken the initiative. The short positions established from 1.1605 should be maintained. Target levels include pivot points at 1.1585 and 1.1545.

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