The Federal Reserve's rate cut in December is imminent. Can the euro's outlook break through 1.20?

Market Weekly Overview

Last week (12/1-12/5), the US dollar index declined by 0.50% under pressure, while non-US currencies rebounded across the board. The Australian dollar led the gains, rising 1.36%; the British pound increased 0.74%; and the Japanese yen and euro also appreciated by 0.53% and 0.36%, respectively. Market focus undoubtedly shifts to the upcoming Federal Reserve December meeting.

Rate Cut Wave Approaching, Euro Outlook Depends on Dot Plot

The certainty of the Federal Reserve rate cut is becoming increasingly strong. According to the CME FedWatch tool, the market currently prices in an 87.2% chance of a 25 bps rate cut at the December 10 meeting, with expectations of two more rate cuts in 2026.

Fundamentals supporting this outlook should not be ignored — US November ADP data unexpectedly weakened, with employment decreasing by 32,000 month-over-month, the largest decline since March 2023. Meanwhile, the September PCE Price Index shows inflationary pressures easing, clearing obstacles for the Fed to cut rates as scheduled.

For EUR/USD, the rate cut expectations are a direct positive. Last week, EUR/USD rose 0.36%, reflecting the market’s early digestion of the dollar’s weakening. However, the real turning point depends on how the Fed “says” it.

Key focus points are the dot plot, bond purchase scale, and Powell’s wording. If the December dot plot hints at more than 2 rate cuts in 2026 or announces an unexpectedly large bond-buying plan, the market will interpret it as a dovish signal, further pressuring the dollar. The euro could then break through 1.18 and even reach the previous high of 1.1918. Conversely, if the dot plot indicates only 1 rate cut and Powell’s language remains hawkish, the dollar will be supported, with EUR/USD facing support at the 21-day moving average of 1.1593 and the previous low of 1.1491.

On the technical side, EUR/USD has broken through the 100-day moving average, with RSI continuing to rise, indicating ongoing bullish momentum. However, the market should also be cautious of a pullback after a rally.

Yen Appreciation Expectations and Reality Gap

USD/JPY fell 0.53% last week, seemingly due to rising expectations of Japanese rate hikes. Reports indicate that Bank of Japan Governor Ueda Kazuo signaled a hawkish stance, with the market pricing in about a 90% chance of a rate hike in December. The Japanese government also expressed tolerance for the BOJ’s rate hike decision.

Interestingly, despite such strong rate hike expectations, the yen’s appreciation has been limited, with USD/JPY still hovering around 155. This reflects the market’s realistic assessment of the long-term real interest rate differential between the US and Japan. Under the expansionary fiscal policies led by Japanese Minister of Internal Affairs and Communications Sanae Takaichi, Japan’s inflation is expected to remain high, but the market only anticipates one rate hike by the BOJ in 2026, making it difficult to significantly narrow the interest rate gap with the US.

Institutional expectations for the yen’s future diverge sharply. Mizuho Securities is bullish on the yen, predicting USD/JPY will reach 158 by the end of 2026; Nomura Securities is bearish, expecting it to fall to 140. This wide divergence reflects the market’s uncertainty about US and Japan policy directions.

This week’s Federal Reserve meeting will be a key catalyst for USD/JPY. If the Fed signals dovishness, USD/JPY may rise; if hawkish rate cuts are announced, downside pressure will prevail.

On the technical side, USD/JPY has broken below the 21-day moving average. Continued pressure could increase downside risk, with support at 153. Conversely, if it reclaims the 21-day moving average, a rebound could open, with resistance at 157.

What Traders Should Focus On

This week, market focus centers on the Federal Reserve rate decision and developments in the Russia-Ukraine situation. Since the market generally believes the European Central Bank has ended its rate-cutting cycle, the path of rate cuts in 2026 by the Fed will be particularly influential for the euro outlook.

In short, this is a currency storm led by the Federal Reserve. Be prepared for volatility.