Euro posts biggest gain in four years…expected to rise to $1.20 in September

Euro strengthens as Fed cuts expected while ECB is seen keeping rates unchanged

Dollar hedging by ETFs buying US stocks and bonds also increases

The euro is showing its largest gain in four years. This is because the US Federal Reserve is expected to cut rates this week, weakening the dollar, while the European Central Bank (ECB) is seen as certain to keep rates unchanged.

On the 16th (local time), the euro rose 0.4% in European trading, surging to $1.1813 against the dollar, its highest level since July 1. Year to date, the euro has risen 14% against the dollar.

According to Bloomberg, if the euro breaks the July high of $1.1829, it would be the strongest level since September 2021. The options market expects there to be a chance of rising to the notable $1.20 level.

The expectation that the Fed will cut rates by 0.25% percentage points at this meeting and then cut rates three more times through early next year is also increasing demand for the euro.

Kit Jukes, head of FX strategy at Société Générale, said in a report, "At present, relative growth outlook, relative rates, and the overall market environment are all favorable for the euro." He added that long bets on the euro have not expanded as much as expected and that the euro is likely to rise to $1.20 within the month.

The one-week risk reversal index, a gauge that measures positioning and sentiment, rose to its highest level in a month. Demand for options that give the right to buy euros has steadily increased since signals that the ECB has finished cutting rates.

According to data from the Depository Trust & Clearing Corporation (DTCC), more than two-thirds of euro-dollar options traded the previous day were bullish bets. Demand for strike prices above $1.20 was also quite high.

According to Morgan Stanley strategists, strategic positioning on the dollar ahead of the Fed decision is neutral. This suggests that if policymakers implement three rate cuts this year, the euro's rise could continue.

Meanwhile, Deutsche Bank’s analysis of exchange-traded funds (ETFs) showed that foreign investors are reducing dollar exposure by using currency hedges when buying US stocks and bonds.

Deutsche Bank said that after examining more than 500 funds, inflows to dollar-hedged ETFs have exceeded inflows to unhedged funds for the first time since 2020. Dollar-hedged funds accounted for more than 80% of total ETF inflows into US equities and 50% of inflows into the US bond market.

George Saravelos, global head of currency research at the bank, pointed out, "Foreign investors are reluctant to be exposed to dollar declines even when buying US stocks or bonds."

The Bloomberg dollar spot index is trading near its 2025 low after falling about 9% this year.

According to US Treasury data, foreigners' holdings of US stocks and bonds fell from February to April and then reached a record high in June.

Kim Jeong-ah, guest reporter kja@hankyung.com