EUR/USD: Structural Bearishness Amid Policy Divergence and Fragile Growth

The persistent weakness in EUR/USD is being driven by a clear and widening policy divergence. On one side, the Federal Reserve is being forced to hold, while on the other, the European Central Bank is constrained to stand still. This creates a structural carry trade incentive that favors the dollar.

The immediate catalyst is a surprise in US labor data. Initial jobless claims fell to about 198k, significantly below expectations. This shows a still-resilient labor market and, combined with sticky inflation concerns, has pushed back market expectations for the first Fed rate cut. Fed funds futures now assign a 95% probability the Fed will hold rates steady at its late-January meeting, reinforcing carry support for the dollar and keeping EUR/USD under pressure.

Meanwhile, the ECB has effectively locked in a policy hold. With Eurozone inflation slowing to 2.0% in December, returning to the ECB's target, and with ECB member François Villeroy de Galhau calling expectations of a rate hike in 2026 "fanciful", the path for easing is clear. The bank left policy unchanged in December, and the market now sees rates remaining on hold for an extended period.

This is the divergence engine. While the Fed is being held back by data, the ECB is being held down by policy. The result is a persistent incentive for investors to borrow in the lower-yielding euro and invest in higher-yielding dollar assets. This carry trade dynamic provides a fundamental floor for the dollar and a structural headwind for the euro, setting the stage for continued pressure on EUR/USD.

The Euro's Fragile Foundation: Growth and Inflation

The structural bearishness in EUR/USD is not just about policy divergence; it is rooted in the Eurozone's underlying economic fragility. While headline inflation has returned to the ECB's target, the growth story is weak and uneven, undermining the euro's appeal as a high-yielding, stable currency.

The most recent data shows a picture of stagnation. Germany's economy grew a meager 0.2% in 2025, ending a two-year contraction. This expansion was driven by household and government consumption, but it was not powered by industry. The persistent weakness in manufacturing keeps the outlook fragile. This is the core vulnerability: a recovery that is not broad-based and lacks the industrial engine needed to support a stronger currency.

At the same time, the inflation narrative has flipped. After a period of elevated prices, Eurozone headline inflation slowed to 2.0% in December, returning to the ECB's target. This is a positive development for monetary policy, as it removes a key reason for the ECB to hold rates high. However, it also reinforces the expectation that the ECB will eventually need to ease, not hike. With ECB officials like François Villeroy de Galhau dismissing rate hike talk as "fanciful," the market sees a path of lower euro interest rates ahead.

This combination of weak growth and cooling inflation is a classic recipe for a bearish currency. Falling German yields, a direct reflection of these economic concerns, are widening the yield gap with the US. When growth is soft and inflation is tame, the incentive to borrow in euros and invest in dollars diminishes. The structural picture on the euro side remains softer, as the ECB is likely to lower rates sooner and by more than the Fed, given the diverging growth and policy paths.

The bottom line is that the euro's fundamentals are not providing a floor. Instead, they are reinforcing the dollar's structural advantage. While the Fed is being held back by resilient US data, the ECB is being pushed lower by a fragile Eurozone economy. This dynamic ensures that the carry trade incentive will persist, keeping the bias bearish on EUR/USD until the growth story in Europe shows more durable strength.

Counterarguments and the Bull Case: What Could Stop the Bearish Momentum?

The bearish thesis on EUR/USD is powerful, but it rests on a fragile equilibrium. The primary catalyst for a reversal would be a significant deterioration in US economic data or a shift in Federal Reserve policy expectations that undermines the dollar's structural advantage. For now, the divergence engine is running hot, but it could stall if the US story weakens.

The immediate test arrives with the upcoming US Non-Farm Payrolls report. While economists expect a modest gain of over 55k jobs in December, the detail matters. The report is also expected to show that manufacturing jobs continued falling, mostly because of Donald Trump's tariffs. This creates a contradictory signal: a resilient labor market coexisting with a sector under direct trade policy pressure. Such a mixed picture could fuel uncertainty, making the Fed more cautious and potentially slowing the pace of its anticipated easing. If the data shows a sharp drop in manufacturing employment, it could spark fears of a broader economic slowdown, weakening the dollar's carry trade appeal.

On the euro side, the ECB's upcoming leadership race introduces a potential wildcard. The bank is set to replace several Executive Board members, with the first vacancy opening in June. While the current policy signal remains firmly dovish, with the ECB not changing its rate since June and inflation hitting its target, a new leadership could bring a different tone. However, the immediate outlook is for policy to remain on hold, with market pricing implying a small chance of a rate cut around the middle of the year. Any shift from the current dovish stance would likely be gradual and reactive to economic data, not a sudden pivot.

The bigger structural counterargument lies in the broader global policy landscape. Bloomberg Economics forecasts a period of less synchronized phase across advanced economies, with central banks like the Bank of Japan and the Bank of England potentially moving in different directions. This splintering could reduce the overall appeal of the dollar as a single, dominant safe-haven asset. Yet, for EUR/USD, the immediate divergence between the Fed's cautious hold and the ECB's effective pause is the dominant force. The bull case hinges on the Fed being forced to cut faster than expected due to a US slowdown, or the ECB being pushed to ease sooner than the market now prices. Until those conditions materialize, the bearish momentum is well-supported.

Technical Setup and Forward Scenarios: Key Levels and Practical Implications

The technical picture aligns with the fundamental bearish narrative, presenting a clear setup for continued downside pressure. The pair is currently trading near 1.15985, which sits just above a critical support zone. This proximity is the first signal to watch. A decisive break below the immediate support at 1.1610 would confirm the bearish momentum and open the path toward the next major target.

The immediate risk is a drop below the 1.1635 level. As noted in technical analysis, a price below 1.1635 poses a risk of testing the 1.1550 level. This 1.1550 zone is a key psychological and technical floor, representing a significant area of prior support. A sustained move through this level would signal a deeper correction and likely trigger algorithmic selling, with the next major target at 1.1480. The weekly range confirms this context, with the pair fluctuating between a high of 1.16915 and a low of 1.15955 over the past week, indicating a tight, bearish consolidation.

The practical implication is straightforward: the current setup favors a continuation of the downtrend unless a major shock occurs. The structural drivers-the Fed hold, ECB pause, and fragile Eurozone growth-are providing the fundamental fuel for the technical move lower. For traders, this means the primary bias is to sell rallies toward resistance, with clear downside targets mapped out. The key levels to monitor are the immediate support at 1.1610, the critical break level at 1.1635, and the major support zones at 1.1550 and 1.1480.

The bottom line is that the technical framework reinforces the macro thesis. The market is in a state of controlled decline, with the current price near 1.1598 acting as a temporary holding pattern. The path of least resistance remains down, and the next major test will be whether the pair can hold above the 1.1635 threshold. A break below would validate the bearish outlook and likely accelerate the move toward the 1.1550 support, where the next phase of the trend would be determined.