Appetite grows while eating. As soon as EUR/USD dropped to 1.0800, speculation about parity resurfaced in the Forex market. Pictet and Deutsche Bank do not rule out the possibility of parity if Donald Trump wins the US presidential election and implements his tariff promises. JP Morgan and ING believe this level could be reached even before the end of 2024. Meanwhile, the main currency pair is moving upwards due to profit-taking on short positions by large speculators.

As the downward trend progresses, the interest in hedging against EUR/USD falling to 1.0500 and below is growing rapidly. The risks of a euro reversal have fallen to their lowest levels in months, indicating the dominance of the bears in the derivatives market.

Euro reversal risk dynamics

In terms of interest rate differentials on debt, the EUR/USD pair should already be trading below 1.0700. There are plenty of reasons for this. The US dollar may benefit from a slower decline in the federal funds rate than currently expected, or from a stronger US economy compared to Europe. Or from a global trade war, especially if Donald Trump returns to power in the US.

At the ECB post-meeting meeting press conference, Christine Lagarde noted that import tariffs would further derail the eurozone's economy. The ECB may be forced to respond to protect the competitiveness of its producers by weakening the euro. Derivatives already see a 30% chance of a 50 basis point cut in the deposit rate in December. The ECB could surprise the market with several broader moves, which would damage the single European currency.

EUR/USD and interest rate differential dynamics

What risks do the bears in EUR/USD face? In my view, the main risk is a sharp cooling of the US labor market. The Federal Reserve has made it clear that its focus has shifted from inflation to unemployment. A rapid rise in unemployment could lead to a scenario where the federal funds rate is cut by 200 basis points to 3% by the end of the cycle. This scenario is already outlined in the latest FOMC forecast for interest rates. The US central bank considers a 3% rate to be neutral, meaning it neither cools nor stimulates the US economy.

Therefore, as long as the US remains economically robust, and the chances of Donald Trump winning the presidential election continue to rise rapidly, the likelihood of EUR/USD continuing its downward path looks realistic. Trade wars will bring pain to the global economy, including pro-cyclical currencies like the euro.

Technically, the EUR/USD's daily chart shows a rebound after a prolonged downward movement. If the bulls fail to break through resistance at the pivot levels of 1.0860 and 1.0905, this will signal their weakness and provide a reason for opening short positions. Target levels are 1.0700 and 1.0580.