Hawkish Fed Tone and German Instability Weigh on Euro

The Euro has declined as the US Dollar recovers recent losses due to a hawkish tone from the Federal Reserve. Fed official Musalem delivered a distinctly hawkish message, warning that inflation is likely to remain above the 2% target over the next 18 months if interest rates do not rise further.

The emphasis on commodity shocks and preference for 'earlier and incremental' hikes rather than 'later and larger' moves reinforces a front-loaded tightening narrative that is supportive of the Dollar and negative for risk-sensitive currencies.

The Euro's struggles are also due to intensifying political instability in Germany, with Chancellor Friedrich Merz's conservative party suffering its worst regional defeat in post-war history.