EUR/USD capped at 1.1644 as Fed hawkishness limits euro gains

The euro traded at $1.1644 on Wednesday, with gains capped as a hawkish repricing of Federal Reserve rate expectations bolstered the US dollar against its major peers.

"The Fed story remains the dominant driver for EUR/USD, with markets pricing a higher-for-longer rate path that keeps the dollar bid," said Francesco Pesole, FX strategist at ING.

The 10-year Treasury yield held at 4.47% after rising from 4.56% late last week, while the dollar index strengthened against a basket of currencies. The S&P 500 climbed 0.6% to a record close Tuesday, with the Nasdaq rallying 1.2%, as easing oil prices — Brent crude falling $3 to $93.89 a barrel — tempered inflation concerns without shifting the Fed's hawkish stance.

The fed funds rate has stood at 5.25% to 5.50% since July 2023, and markets have pushed back expectations for the first cut as inflation data remains sticky. For EUR/USD, the narrowing of rate differentials that had supported the euro earlier this year has stalled, leaving the pair vulnerable to a test of the $1.15 level if the Fed maintains its current posture through the June meeting.

The dollar's resilience comes even as geopolitical risks have eased somewhat. President Donald Trump said negotiations with Iran on ending the war were "proceeding nicely," sending oil prices lower and reducing one source of inflation pressure that had complicated the Fed's policy calculus. Yet the repricing of Fed expectations has proved more durable than the geopolitics-driven dollar moves, with CME FedWatch data showing markets pricing a less than 40 percent probability of a rate cut before September.

The last time the Fed maintained an extended hold at a cycle peak was in 2006-2007, when the fed funds rate stayed at 5.25 percent for 15 months before the central bank began cutting in September 2007. The current hold has now matched that duration, and the persistence of above-target inflation — the core PCE deflator running at 2.8 percent — suggests the Fed may need to extend the pause further.

For the euro, the implications extend beyond the direct rate channel. A sustained dollar bid tightens financial conditions in emerging markets, reduces the appeal of euro-denominated debt, and weighs on European export competitiveness. The European Central Bank faces its own policy dilemma: while euro-area inflation has moderated to 2.4 percent, a weaker euro risks importing inflation through higher energy costs, potentially slowing the pace of ECB easing.

ING's Pesole said the near-term outlook for EUR/USD hinges on whether US economic data — particularly Friday's nonfarm payrolls report — reinforces the hawkish repricing or gives the market reason to reverse it. A strong payrolls print would likely push EUR/USD toward the $1.15 support zone, while a miss could trigger a relief rally toward $1.17.

This article is for informational purposes only and does not constitute investment advice.