2025 EURUSD outlook. What to expect?

After Donald Trump won the election, the USD began strengthening against all major currencies. The U.S. dollar is currently extremely overvalued compared to the currencies of major developed countries. At the same time, markets have significantly lowered their expectations for future rate cuts by the Federal Reserve. This situation creates a high risk of a reversal, particularly if exceptionally weak growth data were to emerge. However, such a scenario is not the central expectation at the moment.

Several factors in the shorter time frame could sustain the dollar's strength, including tax cuts and deregulation attracting capital inflows into US markets. The US economy appears stronger than others, but the dollar's current valuation seems stretched. Concerns about the budget deficit could weaken the dollar later in the year. For the second half of the year, it will be very important whether markets see a positive impact from Trump's policies or if they will not deliver the expected outcomes. The U.S. trade deficit can also widen, regardless of whether or not tariffs are put in place, for as long as spending abroad remains soft.

Why market participants consensus view can be incorrect?

The consensus view that EUR-USD will trade towards parity (and below) is likely to be incorrect because the conditions for a material break lower are not in place. Historically, the euro's decline towards and below parity manifested itself during a massive balance of payments shock. The same is not true at present.

Chart below shows the existing dynamics of the current EURUSD spot with OECD Eurostat PPP (purchasing power parity), which is based on a theory that gives implied "fair" exchange rates based on the relative prices of two countries.

We can see that EURUSD is standing far below "fair value".

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Empirical studies show that exchange rates tend to converge towards their equilibrium rate PPP in the long run.

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Interest rate differentials can persist for longer for EURUSD as the US can still have higher inflation for longer, while the Eurozone is somewhere in the middle between higher for longer-inflation in the US and deflation in China. So there are chances for the Eurozone to normalize inflation (even for some time), and support for the economies in the EU can offer lower interest rates that can boost the economy. Meanwhile, the US with higher rates for longer can have a negative impact in the longer term. Also, there will be no meaningful fiscal stimulus this year. Congressional Republicans and Treasury Secretary Scott Bessent will push for spending reductions to help "pay for" Trump tax cuts.

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• Current Valuation:?EURUSD is trading significantly below its fair value based on Purchasing Power Parity (PPP).
• Dollar Strength:?The USD has been strengthening, but its current valuation appears stretched.
• Interest Rate Dynamics:
• US likely to maintain higher inflation and interest rates.Eurozone positioned between US inflation and Chinese deflation.Potential for Eurozone inflation normalization.

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Potential Scenarios:

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• Short-term: Continued USD strength due to perceived economic robustness.
• Medium-term: Potential USD reversal if growth data weakens.
• Long-term: Convergence towards PPP equilibrium rate.

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Key Risks:

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• US budget deficit concerns.
• Lack of fiscal stimulus.
• Potential widening of US trade deficit.

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Outlook: Cautiously Neutral to Slightly Bullish for EURUSD

?Parity consensus appears unlikely. Expect continued range-bound trading. High volatility likely. Lower probability of significant sustained trend.

• Gradual convergence towards fair value expected.
• Economic policy and inflation trends will be critical drivers.

Recommendations:?Monitor economic indicators, Federal Reserve and ECB policies, and fiscal developments in both regions.

Technicals:

Technically, EURUSD was trading from February 2023 most of the time in a range between 1.05 and 1.10. At the moment the most probable scenario looks like high volatility as well:

1. Downtrend Scenario:?Market fully establishes downtrend below 1.0330 and is supported by strong fundamentals - USD exceptionalism persists, US data works out well while Eurozone stagnation continues. EURUSD reach 1 or below.?
2. Central Scenario:?This is the main focus at the moment; Volatile market context, Non trending.?Most of the time, the market moves in an interval between 1.03 - 1.06 - 1.10 zone.
3. Uptrend Scenario:?Market fully establishes a trend above 1.06 and easily reaches 1.10 and moves much higher. The trend supports better data from the Eurozone while the USD budget deficit widens, and higher interest rates become impossible to reduce as high inflation and employment data worsen. This scenario has lower possibilities.

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Important to notice:

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• U.S. Exceptionalism Far from Guaranteed to Persist: Capital markets are pricing in continued U.S. exceptionalism, ignoring question marks over trade policy and whether the AI revolution will deliver on its promises.
• For the dollar to weaken significantly, major catalysts such as policy shifts or economic surprises are necessary. Treasury Secretary Scott Bessent wants to bring down the dollar. Undervalued currencies like the yen and Brazilian real would soar if that catalyst for a weaker dollar emerges.

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Prepared: Dainius ?ilkaitis/Corphedge analytics

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