The Euro rally may be over. What’s next?

“More persistent inflation and weak growth have already been priced into the market in Europe. Subsequently, US labor market data began to cool and there was a significant drop in oil prices. These factors allowed the Fed to cut by 50 basis points in September and markets to price in a large number of cuts through the end of 2025,” Wieladek says in an interview with Morningstar.

“Essentially, financial markets are pricing in some chance of a US recession next year, making this a story of dollar weakness rather than euro strength.”

For Claudio Wewel, FX Strategist at J. Safra Sarasin, “in the second half of 2023 and 2024, the EUR-USD exchange rate more or less moved in line with the US 10-year Treasury yield. US bond yields have fallen sharply in recent months, providing a new tailwind for the euro.”

Could the Euro continue to rise in Q4?

Now, however, the positions of the Federal Reserve and the ECB will have to be considered. Both central banks have begun their round of monetary easing, but the speed and determination with which they will do so is still up for debate.

Inflation is falling on both sides of the Atlantic, but the market expects the Fed to move a little more aggressively in cutting rates, which closes spreads a bit and leaves room for a stronger euro.

“Given that expectations for US rates have already been revised to a significant extent, we do not believe that the current state of the US economy warrants steeper rate cuts than those already set,” says Claudio Wewel. “So we don’t think there will be any more tailwinds for the euro from the rate side. In our view, the market is more likely to refocus on relative cyclical dynamics going forward, and these have remained weak in the Eurozone according to recent activity indicators. In our view, this suggests that EUR-USD should decline in the short term.”

For James Stanley, senior strategist at Forex.com, EUR/USD looks overvalued. “I think the USD weakness, which was quite deep in the first two months of 3Q, was largely driven by the recovery in USD/JPY, which helped lift EUR/USD,” Stanley writes in a 2 October.

1.12 is a historically high level, and in fact the euro doesn’t seem to have much room to rise against the dollar from here on out. Analysts at Commerzbank, for example, expect the euro to be at $1.11 by the end of the year, and BofA predicts $1.12 by the end of the year.

“Consensus is quickly forming around an October ECB rate cut,” wrote Francesco Pesole, FX strategist at ING, in a note published on October 3. “The Euro can no longer rely on a favorable short-term interest rate differential and a EUR/USD. The 2-year swap rate spread at -110bp is consistent with EUR/USD back at or just below 1,100,” he says.

What Trump or Harris would mean for the dollar

According to Tomasz Wieladek, “the elephant in the room for a future EUR/USD level is really the US presidential election” because “At the moment, there is a high degree of economic policy uncertainty regarding future US trade policy” . Donald Trump’s policies, for example, include a tax hike and a tax cut, which would likely lead to an increase in inflation and consequently a strengthening of the dollar as the Fed keeps borrowing costs higher.

“My prediction,” says the chief economist at T. Rowe Price, “is that if President Trump is elected, EUR/USD will likely settle at 1.05. On the other hand, in case of a Harris victory, we will settle at 1.15″.

The consequences of a stronger or weaker person Euro

A stronger euro could hurt Europe’s main industries, all of which rely on exports. This is especially the case in the automotive industry, which is also facing very strong competitive pressure from China. However, a stronger euro also improves consumers and increases their disposable income.

In such a scenario, according to Wieladek, “investors should focus on firms that are domestically oriented and focus on consumers.”

That said, Wewel is skeptical of such a scenario: “The euro is unlikely to experience headwinds from FX in 2025. On the other hand, we expect the EUR-USD trajectory to be fairly flat, so so the exchange rate should be of less concern. According to our forecasts, most developed countries will experience higher growth than the euro area next year.”

How to hedge against currency risk

Movements of the euro against other currencies have a clear effect on assets held by euro area investors denominated in foreign currencies – just as they speculatively do on euro denominated assets held by investors outside the euro area. In most cases, currency movements and returns are positively correlated, so currency risk usually increases volatility.

Basically, if the foreign currency appreciates against the local currency, the effect will be positive, because the assets denominated in the other currency will gain in value only due to the dynamics of the Forex market. Conversely, if the local currency were to strengthen, it would have a negative effect on foreign assets.

Obviously, the calculation becomes even more complex when assets denominated in different currencies are included in the same basket, as is the case with global equity funds.

For those who want to avoid having to account for currency movements in their investments, a growing number of mutual funds and ETFs offer a hedged share class that aims to minimize currency risk to bottom-line returns.

Hedging is never perfect, and as the following table shows, hedged and currency performance can vary. This is in part because hedge fund classes charge higher fees. For most retail investors, the unhedged option remains perhaps the easiest route, especially when one has a long-term horizon and in the case of global funds where there are many underlying currencies that can move in different directions.