Expectations of aggressive Fed rate hikes push euro to two-week low

• EUR/USD retreats for a second consecutive day, weighed down by broad-based US Dollar gains.
• Expectations of additional rate hikes gather momentum following above-forecast US inflation and hawkish comments from Fed officials.
• The Euro remains under pressure from uncertainty surrounding France’s political and fiscal outlook.

Selling pressure pushes EUR/USD to a two-week low in Wednesday’s American session, extending the pair’s decline into a second consecutive day. Broad-based strength in the US Dollar (USD) weighs on the Euro (EUR), as expectations build that the Federal Reserve (Fed) will pursue a more aggressive course of interest rate hikes.

The pair is trading near 1.1116 at the time of writing, a decline of 0.42% for the day. At around 102.70, the US Dollar Index (DXY) is nearing its year-to-date peak of 102.94, recorded in October. The index measures the Greenback against a basket of six major currencies.

A December Fed rate hike is now fully priced in. According to the CME FedWatch Tool, markets assign an 88.5% probability to a 25-basis-point (bps) rise and an 11.5% probability to a larger 50 bps increase. Expectations extend to further tightening next year, with traders pricing in three more quarter-point hikes by mid-2027.

Behind this reassessment of rates are Tuesday’s stronger-than-forecast US consumer inflation figures and Fed officials’ calls for additional monetary tightening. October’s US Consumer Price Index (CPI) increased 0.4% MoM, exceeding the 0.3% estimate, although the pace eased from September’s 0.6%. Excluding food and energy, core CPI advanced 0.3%, unchanged from September’s pace and above the 0.2% forecast.

Could Waller’s comments put a 50bp Fed hike back in focus and favour the Dollar?

For analysts at MUFG, the policy backdrop, rather than the inflation figures alone, has played the larger role in the latest rate repricing, with “the market rethink … to consider the prospect of a 50bp hike.” Pointing to Fed Governor Waller’s remarks that “a stronger CPI print may warrant a 50bp hike.”, they emphasise that “this is only now being considered because of Waller’s comments before the CPI report rather than the CPI report itself,”

While MUFG continues to regard that outcome as “more a risk than a core view”, the analysts caution that it would “alter the current balanced expectations in the markets across key central banks and shift rate hike expectations much more in favour of the dollar.” Their assessment is that this would “likely prompt a further lurch lower in EUR/USD and bring levels below the 1.1000-level into play.”

In Europe, the Euro faces additional headwinds from France’s continuing political and fiscal difficulties and uncertainty about a possible early exit by European Central Bank (ECB) President Christine Lagarde. These concerns persist despite the ECB’s hawkish policy stance. Markets are pricing in further increases in 2027, while traders expect a December rate hike that would be the central bank’s third this year.