Expectations of Federal Reserve rate cuts are heating up, and the euro exchange rate is approaching a 4-year high?

The weakening of the US dollar has become the main theme in the recent foreign exchange market. As of December 3, the US dollar index stood at 99.24, down for nine consecutive trading days with a total decline of 0.08%. In contrast, the euro against the dollar (EUR/USD) performed remarkably, rising for eight consecutive days to 1.1637, with a clear upward momentum.

Divergence in central bank policies is the key driver

The core reason for the continued pressure on the dollar is the market’s reassessment of the Federal Reserve’s pace of interest rate cuts. According to the latest data from the CME FedWatch Tool, the market currently assigns an 89.2% probability to a 25 basis point rate cut by the Federal Reserve in December, and expects two more rate cuts by 2026. This dovish outlook exerts obvious pressure on the dollar.

Meanwhile, the Bank of Japan’s policy shift is also changing market expectations. The latest data shows that the market’s probability of the Bank of Japan raising interest rates in December has risen to 80%, and this policy divergence is expected to further boost the euro against the dollar.

Historical patterns support further downside

From a statistical perspective, data from the past ten years reveal an interesting seasonal phenomenon: in years when the US dollar index declined in December, the proportion is as high as 80%, with an average decline of 0.91%, making it the weakest month of the year. If this pattern continues this year, the dollar index still has about 2% downside potential.

Changes in policy personnel will reshape the landscape

Personnel changes in the new US government have also become a focus in the forex market. US President Trump hinted at possibly appointing Chief Economic Advisor Hasset as Federal Reserve Chair, sparking a new round of market speculation on the Fed’s policy direction.

Van Luu, head of the global forex department at Russell Investments, assessed that a Fed led by Hasset might adopt a more dovish stance, which would further weaken the dollar. The EUR/USD is expected to break through the 1.19 level and reach a four-year high.

Steven Barrow, head of G10 strategy at Standard Bank, pointed out that multiple factors are jointly exerting pressure on the dollar: narrowing interest rate differentials due to the Bank of Japan’s rate hikes, potential policy adjustments from the Fed’s leadership, and risk aversion caused by trade policy uncertainties. Together, these factors will form a “triple strike” against the dollar.

Tim Baker, analyst at Deutsche Bank’s macro strategy department, added that the dollar index is expected to fall back to near the lows of the third quarter, with about 2% downside from current levels. This adjustment could occur within the remaining cycle of this year or extend into early 2026.

Investor opportunity window

Overall, expectations of Fed rate cuts, divergence in central bank policies, and personnel changes are jointly providing upward momentum for the euro exchange rate. Whether the EUR/USD can break through the near four-year high still depends on the final candidate for the Fed’s new chair and Japan’s policy stance next year.