The EUR/USD Outlook Amid a Dovish Fed and Diverging Global Monetary Policy

The EUR/USD pair stands at a pivotal juncture as diverging monetary policy trajectories across major central banks create a compelling case for strategic positioning in currency carry trades. With the Federal Reserve (Fed) poised to cut rates in 2026, while the European Central Bank (ECB) and Bank of Japan (BoJ) adopt contrasting stances-stability and gradual tightening respectively-the euro's relative strength is gaining momentum. Coupled with bearish USD forecasts from Goldman Sachs and Deutsche Bank, and technical indicators pointing to a breakout in EUR/USD, the case for EUR long exposure in the near to medium term is robust. This analysis explores how these dynamics shape opportunities for carry trade strategies and FX risk management.

Diverging Central Bank Policies: A Tailwind for the Euro

The Fed's projected rate cuts, expected to bring its policy rate to 3.25% by 2026, contrast sharply with the ECB's decision to hold rates at 2% through 2026. The ECB's cautious approach reflects a eurozone economy in a "good place," with inflation near its 2% target and moderate growth. Meanwhile, the BoJ's gradual normalization-projected to raise its policy rate to 1.0% by late 2026-signals a departure from years of ultra-loose monetary policy, supported by inflation near 2% and fiscal stimulus.

This divergence creates a yield differential favoring the euro. Carry trade strategies, which involve borrowing in low-yielding currencies (e.g., the USD) and investing in higher-yielding ones (e.g., the EUR), gain traction as the ECB's rate stability and the BoJ's tightening amplify the euro's appeal. For instance, the BoJ's quantitative tightening and 25-basis-point hikes in late 2025 further widen the gap with the Fed's dovish pivot, incentivizing capital flows into the euro.

Bearish USD Forecasts: Institutional Consensus and Fundamental Drivers

Goldman Sachs and Deutsche Bank have both flagged the USD as overvalued, with projections underscoring its long-term weakening. Goldman Sachs raised its EUR/USD target to 1.25 in 12 months, citing diminished foreign appetite for U.S. assets, slowing U.S. economic activity, and the euro's relative equity outperformance. Deutsche Bank echoed this view, noting that the USD's strength in 2025 was a "resilience trade" that now faces correction according to market analysis.

Fundamentally, the euro's strength is underpinned by European fiscal spending and higher yields compared to the U.S. context according to recent reports. For example, Germany's recent infrastructure investments and France's green energy initiatives are attracting capital inflows, while the U.S. faces political gridlock and a maturing economic cycle. These factors align with the ECB's pause in rate cuts, which reduces the risk of yield compression for euro holders.

Technical Indicators: A Breakout Scenario for EUR/USD

Technical analysis reinforces the bullish case for the euro. EUR/USD is currently trading within a defined range, with key resistance at 1.1679 and 1.1747 and support at 1.1497–1.1505. A breakout above 1.1679 could target 1.1747, a level defined by the 2025 high-week close and a 61.8% retracement level according to technical analysis. Conversely, a break below 1.1497 would signal a bearish reversal, though the RSI at 56.202 and a confirmed double-bottom pattern at 1.1618 suggest a stronger bias toward the upside.

Short-term traders should monitor the FOMC rate decision, as a surprise dovish pivot could accelerate the EUR/USD move. Longer-term fundamentals, including the ECB's rate pause and the Fed's projected cuts, support a range-bound EUR/USD between 1.14 and 1.17 in late 2025, with a projected trend toward 1.20–1.22 by 2026.

Strategic Positioning and FX Risk Management

For investors, the EUR/USD outlook presents a clear opportunity to leverage carry trade strategies. Borrowing in USD (with yields expected to fall to 3.25%) and investing in EUR assets (with yields stable at 2% and potentially rising in 2026) offers a positive carry, amplified by the euro's appreciation potential. However, FX risk management remains critical.

1. Hedging Against USD Resilience: While the bearish USD narrative is strong, unexpected U.S. economic data (e.g., a surprise GDP rebound) could delay Fed cuts. Investors should consider partial hedging via USD call options or stop-loss orders below 1.1497 to mitigate downside risk according to market insights.
2. Dynamic Position Sizing: Given the EUR/USD's volatility, position sizing should align with the breakout scenario. For example, increasing exposure if the pair breaks above 1.1679 while reducing it below 1.1618 could optimize risk-reward.
3. Leveraging Carry Trade Arbitrage: The yield differential between the euro and USD provides a natural hedge against moderate EUR/USD depreciation. However, investors should monitor BoJ policy normalization, as faster-than-expected hikes could compress the EUR/USD spread.

Conclusion

The EUR/USD outlook is shaped by a confluence of divergent monetary policies, institutional bearishness on the USD, and technical indicators pointing to a breakout. The Fed's dovish pivot, combined with the ECB's stability and the BoJ's tightening, creates a favorable environment for EUR long exposure. While risks such as U.S. economic resilience or political shocks exist, disciplined risk management-through hedging, dynamic position sizing, and yield arbitrage-can enhance returns in this strategic setup. For investors seeking to capitalize on global monetary divergence, the euro offers a compelling case for near-to-medium-term positioning.