EUR/USD: Is the Euro Poised to Outperform as Fed-Cut Odds Rise and Risk-Appetite Improves?

The EUR/USD pair has long been a barometer for global economic sentiment, and in 2025, it appears to be entering a pivotal phase. With the Federal Reserve's dovish pivot gaining momentum and risk appetite improving, the euro is increasingly positioned to outperform the U.S. dollar. This analysis explores the interplay of strategic currency positioning, policy divergence, and market dynamics to assess whether the euro's ascent is a sustainable trend or a fleeting correction.

Fed's Dovish Pivot: A Catalyst for EUR/USD

The Federal Reserve's shift toward rate cuts has accelerated in 2025, driven by weak economic indicators and dovish signals from policymakers. As of November 2025, the probability of a 25-basis-point rate cut at the December meeting stands at 87%. This follows a broader expectation of three additional cuts by October 2026, which would bring the effective federal funds rate down to 3.1% from its current 3.88%. Such a trajectory reflects a stark departure from the Fed's hawkish stance in 2023-2024 and signals a prioritization of economic stability over inflation control.

The Fed's dovish tilt is further reinforced by mixed labor market data, including job losses in the ADP four-week cumulative measure and declining consumer confidence. These factors have eroded investor confidence in the dollar's safe-haven status, creating a tailwind for the euro.

ECB Policy Divergence: A Structural Tailwind

While the Fed's rate cuts are central to EUR/USD dynamics, the European Central Bank's (ECB) policy trajectory has been equally influential. Since June 2024, the ECB has cut rates eight times, reducing its benchmark rate to 2%-a level more than double the eurozone's inflation target. This divergence has created a significant interest rate differential, historically favoring the euro.

However, the euro's performance has not always aligned with these fundamentals. In Q4 2024, the EUR/USD pair broke down despite Fed rate cuts, as inflation expectations and rising U.S. Treasury yields bolstered the dollar. Yet, by September 2025, the euro reached a four-year high of $1.1867, reflecting a shift in market sentiment. This reversal underscores the importance of broader economic narratives-such as U.S. trade tensions and labor market slowdowns-in shaping currency flows.

Risk Appetite and Carry Trade Flows

Improving risk appetite in 2025 has further tilted the scales in favor of the euro. A dovish Fed environment weakens the dollar, making it an attractive funding currency for carry trades. Investors are increasingly borrowing in U.S. dollars to invest in higher-yielding assets, including European equities and emerging market debt. This dynamic has been amplified by the potential appointment of Kevin Hassett as the next Fed chair, which has reinforced expectations of accommodative monetary policy.

Carry trade strategies have gained traction as the interest rate differential between 2-year U.S. and German bunds narrowed to 156 basis points-the tightest since April 2024. Such compression historically precedes euro appreciation, suggesting further upside potential for EUR/USD if U.S. yields continue to decline.

Strategic Positioning and Market Sentiment

Institutional positioning data provides additional confirmation of the euro's strength. The CFTC's Commitments of Traders (COT) report for Q4 2025 reveals speculative long positions in the euro reaching 93,000 contracts, the highest since June 2024. This reflects anticipation of a euro rally driven by Fed rate cuts and ECB caution.

The EUR/USD pair has consolidated between 1.1400 and 1.1720, with a breakout above 1.1720 likely to push the euro toward 1.1800 and beyond. Analysts from European desks have set targets of 1.18–1.19 for early 2026, contingent on the Fed confirming its easing path. These projections align with the DXY's retreat to 99.70 and European disinflationary trends, which are reinforcing the euro's long-term appeal.

Conclusion: A Euro-Dollar Rebalance in Progress

The confluence of Fed rate cuts, ECB policy divergence, improving risk appetite, and strategic positioning suggests the euro is well-positioned to outperform the dollar in 2026. While short-term volatility remains a risk-particularly if U.S. inflation resurges-the structural tailwinds for the euro are robust. Investors should monitor the Fed's December decision and the ECB's response to inflation developments, as these will determine the pace of the EUR/USD ascent. For now, the euro's trajectory reflects a market betting on a more dovish Fed and a stabilizing eurozone-a narrative that appears to be gaining momentum.