Traders remained bullish on the euro's rebound on Thursday as the European Central Bank's outlook for a second rate cut in September turned cautious, alleviating concerns about political turmoil in France.

As global markets braced for a swift rate cut from the Federal Reserve, the European Central Bank signaled growing concerns about inflation volatility, helping to sustain gains in the euro, which was near a four-month high after being briefly hit by French political turmoil in June.

The ECB cut its deposit rate from 4% in June, the first time in five years that it has kept it unchanged at 3.75%, with ECB President Christine Lagarde stressing that the central bank is not committed to a particular interest rate path.

In contrast, Federal Reserve Chairman Jerome Powell said on Monday he was more confident that U.S. inflation had indeed eased.

That has at least temporarily helped boost the euro, which has gained more than 2% against the dollar so far this month after falling about 1% in June. The euro fell on Thursday but was still on track for its biggest monthly gain since November.

“The risk of an extreme political scenario in France is decreasing, the market is confident that the Fed will cut rates soon, and we have already started to see the dollar weaken against most currencies,” said Bill Papadakis, macro strategist at Lombard Odier.

But the euro has slipped against the Swiss franc and sterling this month as investors warn that the euro is not an immediate option if Trump wins the U.S. presidential election in November. Trump has proposed import tariffs that could hurt the euro zone economy, revive U.S. inflation and send U.S. interest rates and the dollar higher.

Euro vs. USD, GBP and CHF

Amelie Derambure, multi-asset portfolio manager at Amundi, said: "We expect the interest rate differential between the euro zone and the United States to narrow, which will lead to a depreciation of the dollar. However, the market sees Trump's victory as a positive event for the dollar, so the depreciation of the dollar will be limited before the election."

The dollar's interest rate advantage fades

Money markets are pricing in more than two rate cuts from the Federal Reserve by the end of the year and fewer than two more from the European Central Bank by the end of the year.

The dollar has been far ahead of most rivals for much of the past year, but its dominance is slipping as its interest rate advantage fades. An index measuring the greenback against major currencies is down 2% since July.

The euro, meanwhile, has recovered from a fall to a two-month low against the dollar in June when French President Emmanuel Macron's snap parliamentary election created political instability and put the spotlight on France's crippling budget deficit.

Eurozone members bickered in June over France’s fiscal emergency, reminiscent of the euro zone’s past sovereign debt crisis that brought the bloc to the brink of collapse. But those fears are fading now, with traders demanding a premium over German 10-year bonds to hold French debt at around 65 basis points, after briefly surging to a 14-year high of 85 basis points in June.

ECB slows rate cuts

Lagarde signaled on Thursday that she was concerned about economic growth in the euro zone amid a potential global trade war.

“We think the (ECB) will cut rates in September and again in the fourth quarter, but they are in a slow rate-cutting cycle,” said David Zahn, head of European fixed income at Franklin Templeton.

Benjamin Melman, chief investment officer at Edmond Rothschild Asset Management, pointed out that Trump's promise to raise import tariffs is a serious risk to the eurozone's export-focused economy.

Melman expects the ECB deposit rate to be no higher than 2.5% by the end of 2025, and he is bullish on short-term government bonds as they will benefit from expectations of rate cuts.

Konstantin Veit, portfolio manager at PIMCO, the world's largest bond fund, said he didn't expect big moves in the euro against the dollar. "They (ECB policymakers) are in no hurry," he said.

The article is forwarded from: Jinshi Data