Emotion reversal! Divergence in interest rate path between Europe and America, Wall Street investment banks are bearish on the euro against the dollar to 1.1

Due to market expectations that the United States will raise interest rates at a faster pace than Europe for the remainder of the year, Wall Street banks have been abandoning their bets on the euro strengthening. Institutions such as JPMorgan Chase, Morgan Stanley, and Bank of New York Mellon believe that the euro could fall by more than 3% over the next year, dropping to 1.10 against the US dollar. The euro has already fallen to its lowest level in a year this month, as traders anticipate the Federal Reserve to raise rates in 2026 and no longer heavily bet on the European Central Bank raising rates further. This is a stark contrast to the situation earlier in the year. At that time, the euro broke through 1.20 against the US dollar, reaching its highest level in nearly five years, while concerns about the euro being too strong were still present among European policymakers. However, the Iran war caused oil prices to surge, leading to a high demand for the dollar and thus weakening the euro. Now, with the European Central Bank adopting a cautious monetary policy, the euro is further losing favor in the market. Due to the divergence in interest rate paths between Europe and the US, the euro has fallen to a one-year low against the US dollar. David Adams, a strategist at Morgan Stanley, said, "As medium-term investors unwind their structural short positions on the dollar, the euro is likely to reach 1.10, and with momentum building, speculative investors may flock in." JPMorgan Chase has already lowered its mid-term target for the euro against the dollar for 2027 to 1.10, while Royal Bank of Canada expects it to reach this level only by the end of next year. US Bank and Bank of the West have also revised their expectations. While such forecasts usually adjust with market trends, the extent of this downward revision is particularly notable and is starting to shake market consensus. Currently, the market generally expects the euro to dollar exchange rate to be 1.20 next year. Bearish sentiment in the options market is further escalating, especially in longer-term instruments. The one-year risk reversal index, measuring market sentiment and position structure, is at a new high since March 2025 for the euro's pessimism. This means traders need to pay higher costs to hedge or bet on the euro weakening further over the next year. Markus Jennings, an analyst at Bank of the West, said, "While the dollar may enter a phase of consolidation in the short term, the trend momentum for going long on the dollar is very strong at the moment, making contrarian operations challenging." Option traders are betting on further depreciation of the euro. This momentum for a stronger dollar stems from the latest reversal in market expectations for interest rate paths. Before this month's first FOMC meeting chaired by the new Fed chair Kevin Wash, traders were briefly concerned that he would lower borrowing costs under pressure from US President Trump. However, Wash made it clear that the Fed would not tolerate high inflation, prompting traders to bet on the Fed raising rates this year. Meanwhile, European Central Bank President Christine Lagarde stated that since the ECB has already raised rates this month, there is no need to take a stronger reaction to the impact of the Middle East conflict, as inflation is expected to return to target levels in the medium term. Jeff Yoo of the Bank of New York Mellon said, "We believe the ECB should not have raised rates. Rate hikes weigh on economic growth and further weaken the prospects for the euro. There is a possibility that the euro could fall below 1.10 against the dollar, but we will not aggressively short." Some institutions have a relatively moderate view on the euro: these views suggest that the Fed may also delay rate hikes, be bearish on the dollar's outlook next year, or have a more positive view on the European economy. For example, Bank of America has lowered its euro to dollar exchange rate target from 1.20 to 1.15, but overall maintains a neutral stance on the euro. However, investors bullish on the euro are rapidly reducing their positions. Kito Jukes, Chief Currency Strategist at BNP Paribas, said, "The previous uptrend in the euro has basically come to an end. The energy crisis is destined to be bearish for the euro." He used 2022 as a comparison: when the Russia-Ukraine conflict broke out that year, energy prices skyrocketed, severely impacting the overall economy of the eurozone. As of writing, the euro to dollar exchange rate is at 1.1389.