Euro under pressure, dollar clings to fresh gains

The euro-dollar currency pair trades vulnerable and holds near a more-than-a-month low at around 1.0350 on the first trading day of the year.

EURUSD skates on thin ice as the dollar clings to a more than two-year high, with DXY Dollar Index trading around 108.50 on optimism that the Federal Reserve will reduce interest rates less than previously anticipated this year.

The Fed cut its key borrowing rates by 100 basis points (bps) in 2024 as policymakers were more worried about higher risks to employment than upside risks to inflation.

However, they have guided fewer interest rate cuts for this year amid an upbeat US economic outlook. Additionally, a slowdown in the disinflation trend also compelled officials to favour a gradual policy-easing cycle.

The latest dot plot at the Fed’s Summary of Economic Projections showed that policymakers collectively see Federal Fund rates heading to 3.9% by the end of 2025, higher than the 3.4% forecasted in September.

According to the CME FedWatch tool, the central bank is almost certain to keep interest rates unchanged in the range of 4.25-4.50% in the January meeting.

Going forward, the Dollar will be guided by the US ISM Manufacturing Purchasing Managers Index (PMI) data for December, which will be released on Friday. The PMI is expected to tick lower to 48.3 from the prior release of 48.4, suggesting that the manufacturing sector activities contracted at a slightly faster pace.

The euro could still face selling pressure as the European Central Bank is expected to continue its steady rate-cut cycle until June. This suggests that there will be four interest rate cuts, pushing the Deposit Facility rate lower to 2%.

Market participants expect further policy easing as Eurozone price pressures are on track to return sustainably to the ECB’s target of 2%. Additionally, investors are pricing in a sharp decline in European exports due to higher import tariffs from the US under the incoming Trump administration.

For more cues on inflation, investors await preliminary German and Eurozone Harmonized Index of Consumer Prices (HICP) data for December, which will be released early next week.

Investors will pay close attention to the HICP data as it will indicate whether the ECB will continue easing interest rates at a steady pace of 25 bps or pivot to a larger-than-usual pace of 50 bps.