The EUR/USD is starting the year at practically speaking the lowest point of 2024. Just just three months ago, it was near the highest it had been all year as well. The somewhat rapid drop in the currency pair has come along with speculation that it could soon reach parity. But, can the new year bring in a change in direction?
The decline over the fourth quarter of last year was driven by the change in outlook or the two largest economies in the world. The Euro Area saw its economic indicators largely stagnate, leading analysts to speculate that the ECB would have to cut rates to prevent a return to the low-growth, low-inflation standard for Europe before the pandemic. Meanwhile, an initial scare that the US economy was slowing down was seen resolving, with an incoming Trump presidency seen as keeping the Fed from easing as fast.
New Year, New Central Bank View
While both the ECB and the Fed delivered back-to-back rate cuts in the final quarter of last year, there is ample speculation that the pace of easing will be considerably moderated through 2025. The issue is that both will still have different rates – assuming the economic outlook plays out as planned. That is being reflected in the interest rates, which is keeping the Euro under pressure at the start of the year.
The market is pricing in 100 bps of rate cuts from the ECB this year. Although that averages out to about one cut per quarter, the consensus is the easing will be concentrated at the start of the year. Even ECB doves, like Greek representative Yannis Stournaras, agree that easing will slow its pace going forward. With the first rate decision of the year in the balance, investors will be keenly watching the trove of Q4 data coming out in the next few weeks to get a better gauge of what will happen.
What About the Fed?
Meanwhile, market participants are pricing in just 50 bps of easing from the Fed this year. But that is seen as only having around a 65% chance of happening, with many analysts suggesting that there will be at most one rate cut in 2025. That would widen the Euro-dollar rate gap by 50 bps, keeping downward pressure on the currency pair.
However, this outlook is based on expectations that the US economy will at least keep its current growth pace of around 2.5% (more than doubling the Euro Area’s projected 1.1%), and that tariffs will have an inflationary effect. But Trump is notorious for surprising the markets, and is using the threat of tariffs as a negotiation tactic. That could mean the tariffs might not be applied as quickly as anticipated, or at all. And if they do, a slowdown in global trade could also drag on the US economy.
Inflection Point or Rebound?
As traders look to the new year, they are putting behind the more aggressive rate cutting that characterized currency moves over the last few months. The new attitude could give markets an opportunity to pause in the current trend, at least until the new data comes out.
Additionally, there is the risk of how Trump’s new administration starting on January 20th will actually work. The uncertainty could generate a holding pattern at least at the start of the year, as even central banks seem uncertain about what to do until February.
