February 2025 | Forex Outlook

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As we enter February 2025, the forex market remains dominated by a strong US dollar, with major currencies like the euro potentially oversold but challenging to bet against in the short term. The EUR/USD is expected to trade within a range of 1.03200 to 1.06400, influenced by factors such as ECB policy decisions and potential US trade actions.

Eurozone Inflationary Pressures

The Eurozone’s inflationary pressures have been easing, with headline inflation expected to fall to 2.2% in January 2025, down from 2.4% in December 2024. This trend towards the European Central Bank’s 2% target has allowed for monetary easing, as evidenced by the ECB’s recent 25 basis point rate cut to 2.75%. However, core inflation remains sticky at 2.7%, well above the central bank’s target.

Services remain the largest contributor to inflation at +1.78 percentage points, followed by food, alcohol & tobacco at +0.51 pp.

The ECB projects inflation to reach 2.2% in 2025 and 1.9% in 2026, though the final stages of disinflation may be bumpy.

Market expectations suggest further rate cuts totaling 75 basis points in 2025, potentially boosting European equities.

Despite the overall downward trend, inflation expectations for the next 12 months rose to 2.5% in October 2024, the first increase in nine months.

Impact of ECB Rate Cuts

The European Central Bank’s decision to cut interest rates by 25 basis points to 2.75% in January 2025 has had significant implications for the forex market and European economy. The euro initially weakened against major currencies, with EUR/USD falling to 1.0420, as dovish ECB guidance fueled expectations of further rate cuts. However, the euro subsequently rebounded, climbing 0.7% in the days following the announcement.

The rate cut aims to stimulate economic growth amid weak Eurozone GDP expansion of just 0.1% in Q4 2024.

Inflation in the Eurozone has neared the ECB’s 2% target, allowing for monetary easing.

Markets anticipate three more rate cuts in the first half of 2025, potentially bringing rates to 2% by year-end.

The ECB’s dovish stance contrasts with the Federal Reserve, which has maintained higher rates, contributing to euro weakness against the dollar.

Geopolitical Risks in Forex

Geopolitical events can significantly impact forex markets, causing rapid fluctuations in currency values and presenting both risks and opportunities for traders. These events encompass a wide range of factors, including political instability, trade disputes, armed conflicts, and diplomatic tensions. The forex market’s sensitivity to geopolitical risks is particularly evident in currency pairs involving emerging markets and commodity-dependent economies.

Geopolitical tensions can lead to increased volatility, with the Value at Risk (VaR) index reaching its highest level since January 2024 due to recent Middle East conflicts and U.S. inflation data.

Safe-haven currencies like the Swiss franc and Japanese yen often strengthen during periods of geopolitical uncertainty.

Central bank responses to geopolitical events, such as adjusting interest rates, can further influence currency values and trading strategies.

Traders must stay informed about global political developments and integrate geopolitical risk assessment into their fundamental and technical analysis to make informed decisions.

US Dollar Strength Trends

The US dollar has demonstrated significant strength in recent months, with the US Dollar Index (DXY) surging over 7% since October 2024. This rally has been primarily driven by expectations surrounding President Trump’s economic policies and their potential impact on Federal Reserve monetary stance. The greenback’s advance has been underpinned by robust US services data, resilient retail sales figures, and an uptick in core inflation. Looking ahead to 2025, several factors are expected to contribute to continued dollar strength:

Proposed tariffs: Trump’s potential implementation of a 10% universal tariff and 60% on imports from China could further bolster the dollar.
Economic outperformance: The US economy and stock market are anticipated to continue outperforming global peers.
Safe-haven status: Ongoing geopolitical uncertainties typically benefit the US dollar’s safe-haven status.
Interest rate differentials: The Federal Reserve’s monetary policy, particularly if it maintains higher rates compared to other central banks, could support dollar strength.

However, investors should remain cautious, as unexpected geopolitical developments or shifts in economic data could impact these trends.

Global Trade Implications

Global trade agreements significantly impact forex markets by influencing currency demand, trade flows, and investor confidence. The reduction of trade barriers typically leads to increased trade volumes, affecting the demand for currencies involved in these transactions. For instance, the implementation of agreements like the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) can boost investor confidence and capital inflows, potentially appreciating the currencies of member countries.

Trade policies and geopolitical events can cause substantial currency fluctuations. The US-China trade tensions, for example, led to heightened volatility in both the Chinese yuan and US dollar, while also driving investors towards safe-haven currencies like the Japanese yen and Swiss franc. Forex traders must stay informed about trade policy developments and consider diversifying their currency portfolios to mitigate risks associated with sudden shifts in global trade dynamics. Additionally, changes in a country’s trade balance can significantly impact its currency strength, with trade surpluses often leading to currency appreciation and deficits potentially causing depreciation.

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