Amidst the turmoil in the global foreign exchange market, the Euro emerges as the winner

According to Zhitong Finance APP, in recent days, the global foreign exchange market turmoil has shaken the strong US dollar and prevented the continued decline of the Japanese yen. The euro against the US dollar exchange rate broke through the symbolic $1.10 mark in August, with an increase of over 2.5%, marking the largest monthly increase since November last year, becoming the clear winner in the recent global foreign exchange market volatility.

Previously, traders were disturbed and frustrated. After the unexpected rate hike by the Bank of Japan on July 31st, the Japanese yen suddenly soared, and the expectation of a rate cut in the United States caused the US dollar to plummet across the board. Currently, they are closely watching the subsequent trends.

It is worth mentioning that historically, $1.10 is not an easy level to break through. Just in April, some analysts speculated that the euro might fall to parity. Since the beginning of this year, the euro against the US dollar has performed second only to the pound.

Nevertheless, due to the dovish comments from the Federal Reserve coinciding with market speculation about further easing by the European Central Bank or being constrained by sticky services sector inflation, the market expects the euro to gradually rise from the current level.

Volkmar Baur, foreign exchange analyst at Deutsche Bank, said: "This is a story of interest rate differentials. Inflation on both sides of the Atlantic is declining, but the Federal Reserve is expected to take more aggressive action during the decline, narrowing the interest rate differential and paving the way for a stronger euro."

Market pricing shows that the European Central Bank, which cut rates in June, may cut rates at least twice more, each time by 25 basis points. In contrast, traders expect the Federal Reserve to cut rates by 94 basis points in the remaining three meetings this year, meaning three cuts of 25 basis points and likely one larger cut. This represents a change of about 30 basis points compared to early August, while the pricing changes for the European Central Bank are much smaller.

Prior to this, weak US employment market data raised concerns about an economic recession, causing volatility in the stock and bond markets. Since then, the market has regained lost ground and returned to calm, but expectations of loose policies still persist.

It is certain that the attractiveness of the euro against the dollar is not only due to its strength in August. For traders seeking relatively safe foreign exchange bets, the euro remains the least complicated currency.

After the large-scale arbitrage trades were unwound, the yen experienced sharp fluctuations. French political risks hurt the euro in June. Following the rate cut in the UK and the easing of French political risks, the pound's gains in August have moderated.

Salman Ahmed, Global Head of Macro and Strategic Asset Allocation at Fidelity International, said: "We see some risks to the euro being eliminated, such as the French elections. And now, the central bank story has become clearer."

Becoming increasingly difficult

However, from now on, the euro may find it difficult to make further progress. Analysts say the euro is currently at the top of its recent trading range, and the space for interest differentials to further shift in favor of the euro has narrowed Deutsche Bank expects the euro to dollar exchange rate to remain at $1.11 by the end of the year, in line with the current level. ING Group predicts it will reach $1.12 in a month and then fall back to $1.10, while Bank of America anticipates it to reach $1.12 by year-end.

Mathieu Savary, Chief European Investment Strategist at BCA Research, stated, "Since the second quarter of 2023, my view has been to trade within a range. You buy euros at $1.05 and sell when it breaks $1.10."

For some, this may even be a profit-making opportunity. Guy Stear, Head of Developed Market Strategies at Amundi Investment Institute, said, "This is the highest level the euro should reach from now until the end of the year." He believes that the scenario of further interest rate cuts by the European Central Bank is more convincing than the Federal Reserve.

Recent signs of economic slowdown in the eurozone are evident, with Germany's investor confidence index recording its largest drop in two years in August. In contrast, the next round of US employment data may show that the weak July employment figures were just a temporary effect of Hurricane Beryl.

Another complicating factor is the US presidential election on November 5th. While many factors are at play, analysts suggest that the high tariffs and low tax policies of Republican candidate Donald Trump could lead to higher inflation, meaning the Fed would tighten policy and the dollar would strengthen.

Jane Foley, Head of Foreign Exchange Strategy at Rabobank, pointed out that as the euro has recently strengthened, Democratic vice-presidential candidate Kamala Harris currently holds an advantage in the polls over Trump.

She said, "The real factors that could drive the euro to break through $1.10 and hold that level are Harris's victory and the slowing US economy."