The euro is facing its steepest weekly decline since July, as traders anticipate an interest rate cut by the European Central Bank (ECB) in the coming week. Key options market indicators, such as the one-week risk reversal, have reached their most pessimistic levels in three months, reflecting this sentiment. These options are aligned with the ECB's upcoming decision.
Recently, the euro's strength against the dollar has been more influenced by expected rate cuts from the U.S. Federal Reserve rather than the ECB. Last week's U.S. employment report challenged the idea that the ECB would lag behind the Fed in rate cuts, decreasing the euro's appeal. Traders are also focusing on crucial U.S. inflation data, which might further pressure the euro.
According to several forex traders, hedge funds have increased their short positions on the euro in over-the-counter trading since the U.S. non-farm payroll data was released. The euro is trading around $1.0950, near its lowest point since mid-August, having declined more than 2% against the dollar since the end of September, dropping from $1.12 to just above $1.09. Data from the Depository Trust & Clearing Corporation (DTCC) suggests traders are preparing for the euro to fall towards the $1.08 mark.
In September, the Federal Reserve's significant rate cut initiated an easing cycle, causing the dollar to weaken and the euro to hit a near three-month high. However, this trend reversed in October as market participants began to expect milder rate cuts from the Fed and a more dovish stance from the ECB.
The currency market now anticipates a 45 basis point rate cut from the Fed, with the ECB expected to adopt an even more dovish tone due to weakening economic data and cooling inflation, with a predicted rate cut of 48 basis points. This is a contrast to August and September, when the market expected at least an additional 25 basis points cut from the Fed. San Francisco Fed President Mary Daly indicated that there might be only one rate cut this year.
Currently, markets expect U.S. inflation to slow in September. However, if inflation meets or exceeds expectations, the recent trend between the euro and the dollar might continue. The Fed's latest meeting minutes also revealed some officials' preference for a more gradual pace of rate cuts.
