(Bloomberg) -- The euro was headed for its best week in more than a year as investors pared back expectations for interest-rate cuts and bet that US trade tariffs won’t come into force as soon as previously feared.
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The common currency was on track to strengthen more than 2% to $1.0509, its biggest weekly gain since July 2023. Part of the move can be attributed to the dollar, which has slumped this week.
The weekly gain marks a recovery of a slump in the currency since September, driven in large part by concern that Donald Trump would target Europe with tariffs after his January inauguration. Instead, the new US president has focused his immediate attention on Mexico and Canada, with penalties on Europe expected further down the line.
“The fact that Trump has not immediately implemented tariffs against Europe or other trading partners has helped to partially revert the euro bearish move,” said Roberto Cobo Garcia, head of G10 FX strategy at BBVA, who expects the rebound to continue in the near term. “Valuations, technicals, positioning and market pricing for the European Central Bank all suggest the euro short is a bit overdone.”
A stronger-than-expected German PMI reading also propelled the euro higher on Friday, pushing the two-year German bund yield to its highest level in a week and prompting traders to pull back rate-cut bets. Markets are now pricing around 88 basis points of monetary easing from the European Central Bank this year, compared with 95 basis points on Thursday.
Concern that trade restrictions would worsen the euro zone’s economic slowdown, resulting in deeper rate cuts, had prompted hedge funds and other speculators to raise bets against the euro to the highest level in around three years, according to CFTC positioning data.
A further unwind of these bets could push the euro to $1.0630, an exchange rate breached in early December that’s seen as which is seen as a key resistance level, said Cobo Garcia. George Saravelos, global head of FX research at Deutsche Bank AG, says the euro would likely trade closer to $1.06 in the absence of any tariff risk.
Still, moves in the options market suggest that a rebalancing of short euro positioning, rather than a shift in negative sentiment, has driven this week’s rebound. So-called risk reversals, a barometer of market sentiment, haven’t followed the euro’s spot price move, implying that traders still prefer to own dollar-bullish exposure versus the euro.