Euro Hits Four-Year High As Traders Prepare For Fed Rate Cut

The euro hit its strongest level in four years as traders prepared for an interest-rate cut from the Federal Reserve this week that will cement its diverging trajectory from the European Central Bank.

The common currency climbed to its highest since September 2021 on Tuesday, gaining as much as 0.8% to $1.1853. Data showing investor confidence in Germany’s economic prospects unexpectedly improved helped further underpin euro gains. The Bloomberg Dollar Spot Index weakened, edging close to the lows of this year.

“Speculation that the Fed could be on the brink of a series of rate cuts continues to chip away at the dollar,” said Jane Foley, a strategist in London for Rabobank. At the same time, the “better tone in the German economic optimism release has reignited enthusiasm surrounding the euro,” she said.

The prospect of three full 25 basis-point Fed rate reductions by year-end, combined with expectations that the ECB won’t cut further, is set to narrow the gap between the two central banks’ key rates. Option market suggests that could set the stage for a run at the closely watched level of $1.20.

Higher rates typically benefit a nation’s currency, and while the US is tilting toward loosening as its labor market cools, a wall of defense and infrastructure spending in Europe is expected to spur growth and fan inflation, keeping the ECB on hold — or eventually forcing it to lift rates.

“Relative growth forecasts, relative rates, and the overall market backdrop are all on the euro’s side, for now,” Kit Juckes, head of FX strategy at Societe Generale SA, wrote in a note. Long bets on the euro aren’t as widespread as thought and the chances of a move to $1.20 this month have improved, he said.

One-week risk reversals, a gauge of positioning and sentiment, rose to their strongest in a month, showing a steady rise in demand for options that grant the right to buy the euro since the ECB signaled it’s done easing.

The euro up about 14% in 2025, set for the best nine-month performance on record. The dollar gauge was falling for a second day, declining more than 9% overall this year.

Data from the Depository Trust & Clearing Corporation backed that up: More than two-thirds of euro-dollar options traded Monday were bullish wagers, with notable appetite for strikes above $1.20.

Hedge funds that had previously sought bullish exposure through complex structures are shifting toward simple bets on gains, a sign of growing conviction, according to FX traders familiar with the flows who asked not to be identified because they aren’t authorized to speak publicly.

And according to strategists at Morgan Stanley, tactical dollar positioning is neutral ahead of the Fed decision. That could mean there’s still room for the euro to extend its rally should policymakers validate market bets on three cuts this year.