The Euro has spread its wings

The US dollar is retreating in tandem with declines in Treasury yields and oil prices following the Democrats’ victory in the midterm elections. The greenback is losing ground against G10 currencies, and the euro is one of the main beneficiaries of the improved risk appetite. The acceleration of inflation in the eurozone from 3.8% to 4%, the highest level since September 2023, increases the likelihood that the ECB will tighten monetary policy in December.

The fall in oil prices, driven by expectations that the Democrats will bring the conflict in the Middle East to an end, is benefiting the currencies of energy-importing countries. Brent’s return to pre-war levels at the end of June was a key factor behind the euro’s surge to $1.17 in August. One of the reasons for the subsequent fall of EURUSD in August–October was a divergence in terms of trade: an improvement in US terms of trade, in contrast to the eurozone, supported the dollar.

The currency bloc’s economy has shown remarkable resilience to the ECB’s monetary tightening, US tariffs and high energy prices. A fall in the latter could provide a tailwind for the economy. A likely reason for this resilience is the increase in domestic spending, including on the eurozone’s defence and the creation of an energy system independent of fossil fuel imports.

On the other side of the Atlantic, with the Democrats’ arrival, the risk of a slowdown in investment in artificial intelligence rose briefly due to restrictions on data centre construction. If these fears materialise, they will weigh on US GDP growth and affect employment. Consequently, the Fed is likely to shift from hawkish to dovish rhetoric; in other words, the focus will move from curbing inflation to supporting the economy.

This is all the more likely given that signs of a slowdown in US GDP are already visible. The ISM’s services sector business activity index grew at its slowest pace in the last three months in October, as rising costs are beginning to take their toll. ADP’s private-sector employment growth of 86,000, while above forecasts, is well below the normal rate of around 200,000 seen during periods of expansion. Nevertheless, this still represents growth, and investors regard inflation dynamics as the key variable for the FOMC.

In this regard, the slowdown in annual inflation expectations from 2.7% to 2.1% over the past week, as indicated by the futures market, gives the Fed grounds not to rush into policy tightening.

In the short term, speculators are closing out long positions in the dollar, which is contributing to its weakness, while EURUSD is benefiting from both the greenback’s weakness and hopes of improved terms of trade and an economic upturn in the eurozone.

Summary: The euro is rising as oil and the dollar fall: eurozone inflation at 4% raises the odds of an ECB rate hike, while a cooling US economy gives the Fed a reason not to rush.