How U.S. Policy is Fueling the Euro's Rise

The euro's powerful ascent is no accident. As of February 6, 2026, the EUR/USD rate stood at 1.1812, having rallied 14.37% over the last 12 months. This move is a direct consequence of a shifting monetary policy landscape, where U.S. dovishness meets Euro Area resilience.

The immediate catalyst is the Federal Reserve's stance. In January, the Committee voted to maintain the target range for the federal funds rate at 3‑1/2 to 3‑3/4 percent. While a hold was expected, the decision was notable for the dissent: two members, Stephen I. Miran and Christopher J. Waller, preferred to lower the target range. This split signals internal pressure within the Fed to ease policy sooner, reinforcing a dovish tilt that weakens the dollar's appeal.

Against this backdrop, the European Central Bank has maintained a steady hand. The ECB held its key interest rate at 2% for the fifth consecutive meeting, citing a resilient economy and inflation that is expected to stabilize at its 2% target. This policy divergence creates a clear environment for the euro. With U.S. rates held at a level that may soon be seen as restrictive, and Euro Area fundamentals holding up, capital flows naturally seek the more attractive yield and stability. The result is a sustained rally that reflects a fundamental reassessment of relative value.

The U.S. Engine: Policy Divergence and Political Headwinds

The euro's rise is powered by a specific set of U.S. vulnerabilities. While the Fed holds rates steady, a deeper structural dynamic is at work: the U.S. economy is growing, but not creating jobs. This "jobless growth" pattern, where economic activity has been expanding at a solid pace but employment slowed to the weakest pace since 2020, creates a policy dilemma. The Fed's dual mandate requires it to balance inflation and employment. With inflation still somewhat elevated and job creation weak, the central bank faces a constrained toolkit. It cannot hike rates aggressively to fight inflation without risking a sharper slowdown in the labor market, which would undermine its other mandate. This uncertainty, highlighted by the recent dissent within the Fed over a rate cut, signals a policy that is stuck in neutral, unable to provide the yield premium that would support the dollar.

Political rhetoric is adding another layer of pressure. The White House has openly questioned the Federal Reserve's independence and championed sweeping tariffs. This creates a climate of uncertainty that investors flee. As a result, capital has been flowing into traditional safe-havens like gold, which surged last week, hitting record highs. The president's own public indifference about the dollar's decline has further emboldened this move, signaling a potential shift in official stance that erodes confidence in the greenback's long-term strength.

Finally, the fiscal story is more balanced than often assumed. While the U.S. has a higher long-term growth trend, the gap has narrowed significantly during crises. The euro area's fiscal position is not as contractionary as conventional wisdom suggests. In fact, the capacity of the U.S. to act quickly in crises, smoothing economic cycles through discretionary federal support has been a key driver of its exceptionalism. This means that in recent downturns, the U.S. has run more expansionary fiscal policy than the euro area, which lacks a centralized fiscal mechanism. This fiscal divergence has helped to narrow the growth gap, supporting a more balanced long-term outlook for the euro zone and reducing the perceived need for a dollar premium.

The bottom line is that U.S. policy is creating a perfect storm for the dollar. A dovish Fed, constrained by weak labor data, meets a political environment that openly questions its autonomy and embraces trade protectionism. This combination, viewed against a backdrop of more balanced fiscal policy, is driving capital toward the euro as a more stable alternative.

Financial Impact and Forward Scenarios

The euro's powerful rally is now translating into tangible economic and policy consequences. For the Euro Area, a stronger currency is a double-edged sword. On one hand, it makes imports cheaper, providing a direct, disinflationary pressure. The ECB's own analysis notes that currency appreciation tends to cause disinflation by making imported goods, raw materials and energy cheaper. With inflation already cooling to 1.7% in January, this dynamic reinforces the risk of an undershoot on the central bank's 2% target. On the other hand, it weighs heavily on exporters, who see their goods become more expensive abroad. This creates a clear policy dilemma for the ECB. While the bank has held rates steady, officials are watching closely. As France's central bank governor commented last week, the euro's appreciation is a concern. The bottom line is that the stronger euro gives the ECB more room to maintain its current stance, but it also introduces a new headwind that could force a reconsideration if disinflation risks become too pronounced.

For the United States, the dollar's recent weakness, while not yet a crisis, is being challenged by a fundamental shift in narrative. Political rhetoric is actively questioning the dollar's traditional strength. The White House's public indifference about the dollar's most recent decline and its long-standing view that exchange rates have favored foreign countries signal a potential strategic embrace of a weaker greenback. This "vibe shift" is different from past cycles. It is not driven by market forces alone but by a policy direction that views a weaker dollar as a tool to boost exports and rebalance trade. This creates a persistent headwind for U.S. asset returns. A dollar that is seen as less committed to strength can erode the premium that attracts foreign capital, complicating efforts to finance the country's debt.

The forward path for the euro remains uncertain, hinging on the ECB's next move. The central bank has explicitly stated it will not be "precommitting to a particular rate path," adopting a data-dependent and "meeting-by-meeting approach". This means the euro's strength itself could become the catalyst for change. Officials have warned that further appreciation could prompt a resumption of rate cuts to counter disinflation. Yet, the ECB's broader economic outlook is resilient, supported by solid growth and low unemployment. The key scenario to watch is whether the disinflationary impact of the euro's climb is deemed significant enough to outweigh the benefits of a strong domestic economy. If inflation falls too far, the ECB may be forced to act. If not, the euro could consolidate its gains, sustained by the underlying policy divergence and the U.S. political backdrop.

Catalysts and Risks: What to Watch

The current narrative of euro strength is built on a fragile foundation of policy divergence and political signals. Its durability hinges on a few key near-term events that could confirm the trend or trigger a sharp reversal.

First, watch U.S. labor market data for signs of a sustained pickup in job gains. The Federal Reserve's dovish stance is directly tied to weak employment. As noted in its recent statement, the Committee is attentive to the risks to both sides of its dual mandate, with job gains remaining low. A clear, persistent acceleration in hiring would force the Fed's hand. It would provide the employment catalyst needed to justify a more hawkish tilt, potentially ending the policy divergence that is fueling the euro's rally. Until then, the Fed's internal dissent and data constraints will keep it on hold.

Second, monitor euro area inflation data for any signs of disinflation that might trigger a premature ECB rate cut. The ECB is already watching the euro's appreciation closely, as it tends to cause disinflation by making imported goods, raw materials and energy cheaper. With inflation cooling to 1.7% in January, the central bank faces a clear dilemma. If disinflationary pressure from the stronger currency becomes too pronounced, it could prompt the ECB to resume rate cuts earlier than expected. This would undermine the euro's yield advantage and risk a sharp reversal in its recent gains.

Finally, track any shift in U.S. political rhetoric or policy that could further destabilize the dollar's global reserve status. The White House's public indifference about the dollar's most recent decline and its view of a weaker dollar as a trade tool are already key drivers. Any escalation in rhetoric questioning the Fed's independence or embracing more aggressive trade measures would amplify this effect. The recent surge in gold prices, which hit record highs last week, is a barometer of this uncertainty. A sustained move toward a "weak dollar" policy could permanently erode the greenback's premium, providing a long-term tailwind for the euro that extends beyond cyclical monetary policy.

The bottom line is that the euro's strength is a story of expectations. It will hold so long as U.S. labor data remains soft, euro area disinflation remains manageable, and political rhetoric stays on its current path. Any break in these conditions could quickly reset the narrative.