Euro: Rally Stalls Against Dollar Amid Rate-Differential Trading – Scotiabank

The euro's recent rebound against the U.S. dollar shows signs of stalling. Scotiabank strategists Shaun Osborne and Eric Theoret noted in their latest report that EUR/USD is slightly softer, with upward momentum since late July having clearly faded, and current price action is tracking changes in U.S.-Eurozone yield differentials. As of writing, EUR/USD is trading near 1.16515, having pulled back from its earlier rebound highs.

**Rate Differentials Reassert Dominance Over FX**

Strategists believe the euro's earlier rebound was primarily driven by expectations of tighter European Central Bank policy and temporary U.S. dollar weakness. However, as the market boost from U.S. Treasury buybacks fades, investor attention has shifted back to rising energy prices and inflation rebound risks. The Fed's July meeting minutes showed policymakers remain vigilant on prices, and the market has not fully ruled out another rate hike before year-end. This keeps U.S. Treasury yields elevated, sustaining the dollar's yield advantage and limiting further euro upside.

**Energy and Geopolitical Risks Build a Floor for the Dollar**

Meanwhile, Europe faces its own challenges. Tightening natural gas inventories may force Europe to compete for more LNG in global markets, pushing energy costs higher and slowing the pace of inflation decline, which makes the ECB more cautious in adjusting policy. Additionally, tensions between the U.S. and Iran over the Strait of Hormuz remain unresolved; any escalation could shock global energy prices again, boosting safe-haven demand and underpinning the dollar. Scotiabank's analysis framework suggests that while the euro currently enjoys support from policy expectations, energy and geopolitical risks are building a firmer floor for the dollar, making a sustained trend breakout in EUR/USD unlikely in the near term.

**Market Diverges on Euro Outlook**

Views on the euro's next move are clearly split. In a Bloomberg survey, some analysts expect the euro to strengthen further, projecting a rise to $1.21 per euro next year. However, Credit Agricole analyst Marinov argues that trader expectations are overly optimistic, forecasting the euro to fall to around $1.10 per euro next year. Scotiabank's latest report also hints that with rate differentials back in the driver's seat, the euro's rally against the dollar may have peaked for now.