Can the euro's rally continue? How will the Federal Reserve's rate cuts influence the US dollar exchange rate landscape

Since early December, the rally of the euro against the US dollar has attracted significant attention. The US dollar index fell to 99.24, while the euro surged to 1.1637, reflecting major shifts in global central bank policies. As expectations for Fed rate cuts intensify, downward pressure on the dollar becomes more evident, and the euro benefits from policy divergence. So, can this euro appreciation continue? How much further can the dollar fall?

The Seasonal Weakness of the US Dollar in December: What Do Historical Data Say?

Historical data reveal an interesting pattern—the dollar tends to perform poorly in December. Over the past ten years, the dollar index has declined in eight of those Decembers, with an 80% probability and an average decline of 0.91%, making it the worst month of the year. This seasonal characteristic reflects year-end liquidity shifts and market expectations for economic prospects at year’s end.

According to CME FedWatch data, the market at the time priced in an 89.2% chance of the Fed cutting rates by 25 basis points in December. This widespread consensus on easing policies further pressured the dollar. Additionally, the market still anticipates two more rate cuts by 2026, making it difficult for the dollar to rebound in the short term.

Fed Policy and Bank of Japan Rate Hikes: A Double Blow to the Dollar

The core reason for the continued pressure on the dollar stems from an imbalance in policy expectations. The Fed’s rate-cut cycle contrasts sharply with the Bank of Japan’s inclination to raise rates. Data showed that the market expected an 80% chance of the BOJ raising rates in December, exerting noticeable downward pressure on the dollar.

More critically, the market focused on the potential successor to Fed Chair Powell. U.S. President Trump hinted at possibly appointing Chief Economic Advisor Haskett as Fed Chair. Van Luu, head of global FX at Russell Investments, noted that under Haskett’s leadership, the Fed might adopt a more dovish stance, further weakening the dollar. The euro/dollar exchange rate could even break through this year’s high of around 1.19, reaching a four-year high.

Three Drivers Behind the Breakout: Tariffs, Rate Hikes, and Leadership Changes

Steven Barrow, head of G10 strategy at Standard Bank, offered a comprehensive analysis. He believes that rate hikes by the Bank of Japan, Haskett’s leadership at the Fed, and unfavorable tariff rulings will create a triple impact on the dollar. These intertwined factors pose significant downside risks for the dollar. Even if these shocks don’t fully materialize in the final weeks of the year, they are expected to have more profound effects in early 2026.

Deutsche Bank macro strategist Tim Baker provided specific technical targets. He expects the dollar to fall back toward its lows from the third quarter of this year, implying an additional decline of up to 2% in the dollar index. This forecast offers a clear support level for euro appreciation.

Opportunities and Challenges for the Euro: The Logic of Appreciation Amid Policy Divergence

Against the backdrop of policy divergence, the euro has undoubtedly become the biggest beneficiary. As the dollar weakens relative to other currencies, the euro’s rally continues, reflecting market expectations of Fed easing and recognition of the BOJ’s tightening stance.

Expert consensus further reinforces the euro’s upward outlook. Both Russell Investments and Standard Bank are optimistic about further euro gains driven by policy divergence. However, the euro’s appreciation path is not without obstacles; external factors such as tariffs and geopolitical risks could still disrupt the exchange rate landscape.

Looking ahead to 2026, the euro/dollar trend will continue to be influenced by multiple factors, including the Fed chair appointment, the pace of BOJ rate hikes, and US tariff policies. Investors should closely monitor these policy developments to better seize opportunities in euro exchange rate investments.