EUR/USD rises as US Dollar eases ahead of Fed interest rate decision
- EUR/USD extends gains as the US Dollar weakens ahead of the Fed interest rate decision on Wednesday.
- Fed rate-cut expectations trimmed sharply amid Oil-driven inflation risks.
- ECB faces a difficult trade-off between inflation pressures and slowing growth.
EUR/USD edges higher on Tuesday, extending gains for a second consecutive day as a softer US Dollar (USD) lends support to the Euro (EUR), with market focus gradually shifting from the ongoing US-Iran war to upcoming monetary policy announcements from the Federal Reserve (Fed) and the European Central Bank (ECB). At the time of writing, the pair trades around 1.1546, rebounding from an intraday low near 1.1466.
Meanwhile, the US Dollar Index (DXY), which measures the Greenback's value against a basket of six major currencies, trades near 99.50 after failing to extend gains above the 100 mark earlier in the day.
The Fed is set to announce its interest rate decision on Wednesday, with markets widely expecting the central bank to keep rates unchanged at 3.50%-3.75%. The focus will be on Fed Chair Jerome Powell’s forward guidance, as investors look for clues on how policymakers assess the impact of rising Oil prices on the inflation outlook.
The Fed faces a delicate balancing act, with inflation remaining sticky while higher energy costs pose additional upside risks at a time when the labor market is showing signs of softening. However, traders have sharply scaled back easing expectations, with only around 25 basis points (bps) of rate cuts priced in by year-end, down from earlier expectations of more than 50 bps before the US-Iran war erupted.
According to the CME FedWatch Tool, the Fed is expected to remain on hold through April, June and July. September is currently seen as the most likely timing for a rate cut, with a probability of around 50.8%.
Markets will also watch the updated Summary of Economic Projections (SEP) and the dot plot for signals on the future path of interest rates.
In the Eurozone, the Oil-driven inflation shock is putting the ECB in a difficult position. The central bank will announce its policy decision on Thursday and is also expected to keep all three key interest rates unchanged.
Higher Oil prices could weigh on Eurozone growth, given the region’s heavy reliance on energy imports, while keeping inflation elevated.
Before the conflict, markets expected the ECB to stay on hold through 2026, with officials suggesting policy was in a good place and inflation was under control. However, the outlook has since changed, with traders now pricing in a possible rate hike as early as July.
Investors will also focus on the Eurozone inflation data due on Wednesday, which could offer fresh clues on the ECB’s policy outlook ahead of Thursday’s decision.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
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