European Equities Resilience Amid Dollar Strength in H2 2025

The second half of 2025 has been defined by stark divergences in global monetary policy, with the U.S. Federal Reserve (Fed) and European Central Bank (ECB) charting markedly different paths. While the Fed has embarked on a cautious easing cycle-cutting the federal funds rate by 100 basis points since late 2024-the ECB has paused its rate-cutting trajectory, holding its key rate at 2.00% as inflation approaches its target, according to a MarketMinute analysis. This divergence has fueled a sharp appreciation of the euro against the U.S. dollar, reshaping capital flows and creating a tailwind for European equities.

Monetary Policy Divergence and FX Volatility

The Fed's rate cuts, driven by a softening labor market and stubborn inflation above 2%, contrast with the ECB's more neutral stance. By mid-2025, the EUR/USD exchange rate had surged over 13% year-to-date, peaking at 1.1868 on September 16, according to EUR/USD historical rates. This strength was amplified by the ECB's decision to halt rate cuts, as inflation in the Eurozone fell closer to its 2% target and growth revised upward. Meanwhile, the Bank of Japan's tentative tightening cycle and the PBOC's targeted liquidity injections added further complexity to global capital flows, as noted in a midyear macro outlook.

The dollar's relative weakness, particularly against the euro, has been a critical factor in European equities' outperformance. The MSCI Europe Index delivered a 26% year-to-date return in USD terms through September 2025, dwarfing the MSCI USA Index's muted performance, according to the Syfe market outlook. This was not merely a function of currency movements but also reflected structural shifts: European equities traded at a forward P/E of 12.6x-below its 20-year average-and benefited from fiscal stimulus, such as Germany's EUR 1 trillion spending plan, according to an Allianz Global outlook.

Currency Risk Mitigation: Strategies in Action

Despite the euro's strength, European corporates faced heightened currency risk due to geopolitical volatility and mixed economic signals. To navigate this, 86% of European firms actively hedged their foreign exchange (FX) exposure in H2 2025, with an average hedge ratio of 49% and hedging horizons of 5.3 months, according to corporate FX hedging trends. Companies like Novo Nordisk and British American Tobacco, which derive significant revenue from the U.S. but maintain limited North American operations, leveraged forward contracts and multi-currency invoicing to lock in favorable rates and offset dollar strength, as noted in a Euronews article.

For instance, forward contracts allowed firms to hedge against sudden reversals in the EUR/USD trend, such as the 300-pip swing in April 2025 triggered by U.S. tariff announcements, per an Edge Forex analysis. Others adopted natural hedging by balancing USD inflows and outflows, while currency options provided flexibility to capitalize on favorable rate movements without capping upside potential, as explained in an Investopedia guide.

Outlook and Implications

Looking ahead, the euro's trajectory remains tied to the Fed-ECB policy gap. While the Fed has signaled further rate cuts in 2025, the ECB's pause suggests the dollar may stabilize-but not rebound-against the euro. This environment favors European equities, particularly in sectors with strong U.S. revenue exposure and defensive characteristics. However, investors must remain vigilant: rising hedging costs (up 98% for European corporates in the past year), according to a Monex insight, and geopolitical risks could reintroduce volatility.

For now, the interplay of divergent monetary policies and effective currency risk strategies has underpinned European equities' resilience. As global markets navigate this complex landscape, a nuanced approach to FX management and sector selection will be critical for capitalizing on emerging opportunities.