The baseline outlook for the EUR remains bearish due to the dovish stance of the ECB, expectations of further rate cuts in 2025, a sluggish economy, and ongoing political risks. Meanwhile, the Fed is widely anticipated to implement a 25bp rate cut this week, but market attention will likely pivot to the updated SEP projections and Powell's tone, both of which are expected to convey a 'hawkish' message, providing additional support for the USD heading into 2025.

EUR: Require new downside catalyst

The base line of the EUR remain bearish following the ECB's December meeting, where a 25bps rate cut to 3.00% was delivered, alongside the removal of references to "keeping policy rates sufficiently restrictive for as long as necessary." This shift signals an increased likelihood of further rate cuts as the ECB moves towards a neutral stance. The accompanying macroeconomic projections highlighted downward revisions in inflation and growth forecasts, with headline inflation expected to average 2.4% in 2024 and tapering to 1.9% by 2026, while growth is projected at a sluggish 0.7% for 2024 and 1.1% for 2025. Lagarde's cautious tone during the press conference underscored the ECB's data-dependent, meeting-by-meeting approach, though she did acknowledge the policy stance remains restrictive and hinted at a clear direction for further easing. Despite this, she avoided discussing the neutral rate, highlighting significant uncertainty surrounding future policy paths.

Compounding the bearish outlook, recent confidence indicators in the Eurozone have weakened, and stagflation risks are becoming more pronounced. Headline inflation has accelerated even as economic activity remains fragile, with risks heightened by potential adverse effects of US trade policies, political instability in France and Germany, and a brewing public finance crisis in France. Moreover, the ECB's projections do not account for potential fallout from Trump's trade policies, which are expected to pressure European exports and growth. The OIS market reflects these concerns, pricing in a policy rate between 1.50% and 1.75% by late 2024, with MUFG noting the possibility of a 50bps cut at one of the next two meetings should economic data weaken further.

Overall, the EUR faces significant downside risks as the ECB signals further easing amidst deteriorating economic conditions and increasing geopolitical uncertainties. With the market pricing in more rate cuts, the EUR/USD is likely to remain under pressure, particularly given the elevated likelihood of Trump imposing aggressive trade tariffs and the persistent economic fragility within core Eurozone economies. Looking ahead, market attention will shift to Eurozone preliminary PMI data and the November final CPI report. The November PMIs already show contraction across much of the Eurozone, and further disappointing data could confirm that the region is heading into a recession in 2025. Such developments would increase the likelihood of a 50bps rate cut at the ECB’s January 2025 meeting, adding additional pressure on the EUR.

USD: 25bp cut is sure thing, but 2025's outlook is the market focus

The USD outlook remains bullish, driven by the potential divergence in monetary policy between the US and other countries, the returning of Donald Trump to the presidency, and the challenges faced by the Federal Reserve in its monetary policy easing cycle. The November US CPI report reinforced expectations of a Fed rate cut at the December meeting, with headline CPI (M/M) rising 0.3% or 0.313% unrounded (previously 0.2%) and Y/Y increasing to 2.7% (previously 2.6%). Core CPI (M/M) also rose 0.3% or 0.308% (previously 0.3%), while the Y/Y figure held steady at 3.3%. In response, money markets now show a 94% probability of a 25bps cut, up from 84% before the data release. While ING highlights that core inflation has stalled at 0.3% M/M for four consecutive months, progress toward the Fed’s inflation target remains limited. Nonetheless, the Fed’s preferred inflation measure shows better progress, and cooling labor market conditions support the case for a December rate cut. ING expects the updated SEP to project a shallower path for rate cuts in 2025. Meanwhile, the November PPI came in hotter than anticipated, with headline PPI rising to 3.0% from 2.4% and core PPI increasing to 3.4% from 3.1%. While this data likely won’t alter the December meeting’s outcome, where a 25bps cut is expected, it could translate to higher PCE figures, though not all inflation gains will directly impact PCE.

Looking ahead, market focus will shift to December US PMI data, November retail sales, Q3 GDP, November core PCE, and the December FOMC meeting. The PCE report and FOMC meeting will be particularly important, as they could influence the Fed’s 2025 outlook. While a 25bps rate cut in December is nearly certain, the focus will be on Powell’s commentary and the SEP, which may incorporate potential Trump administration policies expected in January 2025. Powell recently reiterated his confidence in the economy’s resilience, stating there is no reason it cannot sustain its current performance. He also noted that the Fed is cautiously moving toward neutral rates and sees fewer downside risks than previously. If Powell maintains this cautious tone and the SEP reflects stronger growth and inflation assumptions, the USD could strengthen further heading into 2025.

The November PCE report, set to be released after the FOMC meeting, will attract significant attention. Stronger-than-expected data could bolster the Fed’s cautious outlook for 2025, particularly if the FOMC adopts a hawkish or measured tone during the meeting, providing additional support to the USD in the medium term. Overall, the USD is fundamentally underpinned heading into 2025 by the Fed’s cautious stance, diminished prospects for aggressive rate cuts, and the potential impact of Trump’s policies—such as tax cuts, tariffs, and immigration reforms—alongside resilient US economic performance.