Euro struggles as Fed rate-hike bets overshadow ECB tightening expectations

EUR/USD trades on the back foot on Monday, pressured by a stronger US Dollar (USD) as the US-Iran stalemate keeps Oil prices elevated, pushing US Treasury yields higher and strengthening expectations of further Federal Reserve (Fed) rate hikes. At the time of writing, the pair trades around 1.1368, down 0.20%, close to levels last seen in June.

Reuters reported on Monday, citing a source briefed on the negotiations, that mediators are expected to hold separate talks with US and Iranian officials on Monday or Tuesday. The discussions will focus on an amended version of Iran’s seven-day proposal to reopen the Strait of Hormuz, which US President Donald Trump rejected over the weekend.

The US 10-year Treasury yield has risen to 5.27%, its highest level since 2007, while the US Dollar Index (DXY), which tracks the Greenback against a basket of six major currencies, holds near 101.22, close to a two-month high. Markets see a 70% chance of another Fed rate hike in October, according to CME FedWatch, after the central bank raised rates by 25 basis points at its September 15–16 meeting.

Recent Fed comments also suggest policymakers remain open to further tightening as they work to bring inflation back to the 2% target. Traders now turn to a packed week of US data, including the Personal Consumption Expenditures (PCE) inflation report on Wednesday, the ISM Manufacturing Purchasing Managers’ Index (PMI) on Thursday and Nonfarm Payrolls (NFP) on Friday.

On the Euro side, expectations that the European Central Bank (ECB) could continue tightening after raising rates twice this year have done little to support the currency. Analysts at HSBC argue that the Euro “remains vulnerable to uncertainty over the European Central Bank’s appetite to raise rates,” especially in light of the Fed’s “more hawkish messaging at its September meeting.” They add that “even if the relative rates story does not drive dramatic moves in EUR-USD, Europe’s greater exposure to elevated energy costs could weigh on growth and the external balance.”

Speaking on Monday, ECB President Christine Lagarde said, “We still see upside risks to inflation and downside risks to growth.” She added that “the outlook continues to be surrounded by high uncertainty” and that “the inflation outlook will be higher in 2027 and 2028 than we expected a few months ago.”

Lagarde said, “We see higher inflation ahead but no signs yet that it is becoming embedded.” She added, “We view a measured response as appropriate to keep inflation in check.” She also said rates were at the upper end of the neutral range, but stressed that the ECB was not setting policy by reference to the neutral rate.