**The Federal Reserve's signal of a potential 2026 rate hike has triggered a dollar rally that pushed the euro below $1.15 for the first time in two weeks.
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Euro capped below $1.1525 as hawkish Fed fuels dollar rally
The Federal Reserve's signal of a potential 2026 rate hike has triggered a dollar rally that pushed the euro below $1.15 for the first time in two weeks.
The euro traded below $1.1525 on Thursday, its weakest in two weeks, as the Federal Reserve's signal of a potential rate hike this year drove the Bloomberg Dollar Spot Index up 0.4%.
"The Fed's hawkish hold has reset dollar expectations, with the market now pricing in a rate hike that wasn't on the radar a month ago," said Jane Foley, senior FX strategist at Rabobank.
The euro slipped 0.3% to $1.1490 in European trading, breaching the $1.15 support level for the first time since June 3. The dollar strengthened against all Group-of-10 peers, with the yen falling 0.5% to 158.20 per dollar and the British pound declining 0.3% to $1.2680. Two-year Treasury yields rose 8 basis points to 4.32% as traders repriced rate expectations following the Fed's quarterly summary of economic projections.
The divergence between a hawkish Fed and a European Central Bank that cut rates in April is widening the interest-rate differential in favor of the dollar, threatening to push EUR/USD toward the $1.12 level last seen in March. The next key test comes with euro-area inflation data due July 2, which will shape expectations for the ECB's September meeting.
The Fed's June 17 decision to hold the fed funds rate at 5.25%-5.50% was widely expected, but the accompanying Summary of Economic Projections caught markets off guard. Nine of 18 FOMC officials projected at least a quarter-point increase before year-end, a sharp reversal from March when the median forecast pointed to two cuts. The hawkish repricing sent the Bloomberg Dollar Spot Index to its highest level in a month.
The shift reflects the Fed's growing concern about inflation, which has been running stubbornly above its 2% target. The committee now expects PCE inflation to average 3.6% by year-end, up nearly a full percentage point from the March projection, driven in part by the energy price shock from the Iran conflict. New Fed Chair Kevin Warsh, leading his first FOMC meeting, emphasized price stability in the post-meeting statement, saying the committee "will deliver price stability" — language stronger than previous communiques.
The euro's decline accelerated after it failed to hold above the $1.1525 resistance level, a ceiling that has capped gains since early June. The common currency has now erased all of its post-ECB meeting gains from April, when the central bank delivered its first rate cut since 2019. The last time EUR/USD traded below $1.14 was in March, when the dollar strengthened during the initial shock of the Iran conflict.
Rate Differentials Widen to 180 Basis Points
The interest-rate gap between the U.S. and the euro area is the primary driver of the current dollar strength. Two-year U.S. Treasury yields at 4.32% now stand 180 basis points above their German bund equivalent, the widest spread since April. That differential reflects the growing policy divergence: the ECB cut its deposit rate to 2.75% in April and has signaled further easing, while the Fed is now contemplating a hike.
"The market is pricing in a 180-degree turn from the Fed," said Athanasios Vamvakidis, head of G-10 FX strategy at Bank of America. "If the Fed delivers a hike while the ECB continues cutting, EUR/USD could test $1.10 by year-end."
The dollar's strength is rippling through other asset classes. The S&P 500 fell 0.6% on Wednesday after the Fed decision, while gold slipped 0.8% to $2,318 an ounce as the stronger dollar reduced the appeal of the precious metal. Emerging-market currencies bore the brunt of the selloff, with the Mexican peso and South African rand each losing more than 1% against the greenback.
What's Next for the Euro
The euro's near-term trajectory hinges on two factors: the pace of U.S. economic data and the ECB's policy path. If Friday's U.S. personal consumption expenditures report shows inflation remaining sticky, the case for a Fed hike strengthens, potentially pushing EUR/USD below $1.12. Conversely, a soft inflation reading could ease pressure on the euro.
The last time the Fed signaled a rate hike after a prolonged hold was in 2022, when it delivered a 25-basis-point increase in March following a period of elevated inflation. The dollar rallied 8% against the euro over the subsequent three months, a pattern that some analysts see repeating if the current trajectory holds.
CME FedWatch data shows the probability of a quarter-point hike by December has risen to 85%, up from 60% before the meeting. The next FOMC meeting is scheduled for July 28-29, though most economists expect any move to come at the September or November meetings.
This article is for informational purposes only and does not constitute investment advice.
[1] Euro remains capped below 1.1525 weighed by post-Fed US Dollar strength[2] Fed holds interest rates steady: Here's what that means for credit cards, savings rates, mortgages and car loans[3] What The Fed's Rate Decision Means For Your Finances[4] Warsh promises a new vision for the Fed, as his colleagues eye a rate hike instead of a cut[5] Chairman Warsh abstains from giving rate forecast as several members signal a hike in 2026
