Euro: Benefits from US Dollar weakness – DBS

EUR/USD: Moderately bullish, but increasingly vulnerable to a “buy the rumor, sell the fact” reaction.

The key market shift is a widening policy-expectation advantage for the euro: Eurozone July headline and core CPI met forecasts at 2.9% and 2.5% year-on-year, while markets were pricing roughly 26 basis points of ECB tightening for September with more than 90% implied probability. At the same time, uncertainty over the Federal Reserve’s next move is limiting demand for the dollar.

For EUR/USD, this combination supports further upside because:

• Relative-rate expectations favor the euro, increasing the carry appeal of EUR positions versus USD.
• Soft or ambiguous US data would reinforce dollar selling, particularly if it lowers expectations for Fed tightening or raises expectations of easing.
• USD weakness can become self-reinforcing if investors reduce dollar exposure across currencies, commodities, and global risk assets.

However, much of the ECB repricing appears to be reflected already. With a September hike priced at very high probability, the euro may require either a stronger ECB signal, more persistent Eurozone inflation, or a clear deterioration in US data to extend its advance. A confirmation of the ECB move could therefore produce limited additional upside if guidance does not indicate further tightening.

The principal downside risk is a reversal in the US-rate narrative. Stronger US activity, firmer inflation, or hawkish Fed communication would challenge the current dollar-negative positioning. Conversely, an ECB hike accompanied by concern over weak Eurozone growth could steepen the initial move but undermine the euro’s medium-term support.

Trading focus:

monitor US inflation, labor-market and activity data; Fed communication; ECB guidance on the path beyond September; and whether EUR/USD can hold gains after the ECB expectations become fully realized. The immediate bias is positive for EUR/USD, but the medium-term outlook remains conditional on the persistence of US Dollar weakness and the ECB’s willingness to signal additional tightening.