Will Germany follow in the UK’s footsteps? Could the German chancellor be replaced in order to save the ruling party? If so, continued capital outflows from Europe to the US could put further pressure on the EUR/USD. Let’s examine this scenario and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- The likelihood of a Fed rate hike in October–December is increasing.
- Capital inflows are supporting the US dollar.
- Rising political risks in Germany are weighing on the euro.
- Short positions can be opened with targets of 1.14 and 1.13.
Weekly Euro Fundamental Forecast
Trust is easy to lose but hard to regain. Kevin Warsh, however, seems to have done just that. He has convinced investors that the Fed is prepared to fight inflation to the bitter end. Alongside expectations of higher interest rates, renewed demand for US assets is also supporting the US dollar. Otherwise, how can we explain the EUR/USD struggling to rise amid a rapid rally in the S&P 500 and a decline in Treasury yields?
S&P 500 Performance and 10-Year US Treasury Yield
Source: Bloomberg.
Two themes are driving market sentiment: the US-China presidential summit and Saudi Arabia’s ability to restore oil supplies. The first is raising hopes that Washington and Beijing will not restrict the development of artificial intelligence technologies, providing additional support for the S&P 500. The second has triggered a four-day decline in Brent prices—the longest losing streak in three months—and is also providing a tailwind for equity markets.
The US dollar is benefiting from American exceptionalism as investors continue to flock to US assets. At the same time, expectations of further Fed tightening are rising. The derivatives market currently prices in a 55% probability of another rate hike in October. Over the past week, the probability of two additional rounds of monetary tightening in 2026 has risen from 28% to 43%.
These expectations are being reinforced by increasingly hawkish remarks from FOMC officials. Chicago Fed President Austan Goolsbee warned that responding to prolonged supply shocks with tighter monetary policy could hurt the US economy. His counterpart at the St. Louis Fed, Alberto Musalem, argues that without continued tightening, inflation is likely to remain above the 2% target. From this perspective, another federal funds rate hike may be necessary.
Meanwhile, capital appears to be flowing into US assets, potentially at the expense of European markets as political risks mount. The regional election setback suffered by Friedrich Merz’s party has brought the possibility of a change in Germany’s chancellorship back into focus. Could Germany follow Britain’s example? In the UK, an improvement in the Labour Party’s polling numbers followed Andy Burnham replacing Keir Starmer as prime minister. Moreover, recent polls have even put Labour ahead of Nigel Farage’s Reform UK. Could a similar political reset in Germany produce a comparable shift in investor sentiment?
Results of Regional Elections in Germany
Source: Bloomberg.
If the Fed outpaces the ECB in terms of monetary tightening, capital could continue to flow from Europe to the US, creating significant downside pressure on the EUR/USD. That flow could accelerate if the latest S&P Global PMI data reinforces the narrative of American exceptionalism.
Weekly EURUSD Trading Plan
EUR/USD bulls have failed to pierce the 1.1495 resistance level, signaling a lack of buying momentum. This opens the door to short positions, with potential targets at 1.14 and 1.13.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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