EUR/USD holds near 1.14 as Fed faces 37% rate hike odds

The Federal Reserve's two-day policy meeting starting Tuesday will determine whether the dollar extends its rally or the euro finds a floor.

The Federal Reserve convenes Tuesday with markets pricing a 37% probability of a rate hike, the first since 2023, as Brent crude above $100 a barrel reignites inflation fears and pushes 10-year Treasury yields to 4.71%, the highest since early 2025.

"When Warsh goes silent, the bond market goes screaming," said Charles Tan, chief investment officer of global fixed income at American Century Investments, referring to Chair Kevin Warsh's abandonment of the Fed's long-standing practice of signaling the likely path of rates beforehand.

EUR/USD traded at 1.1369 Monday, holding near its recent lows after Friday's decline in energy prices briefly eased rate-hike expectations. The Nasdaq Composite fell 745 points, or 2.9%, last week, while the S&P 500 dropped 77 points to 7,411.98. Thirty-year Treasury yields touched 5.19%, approaching levels last seen nearly two decades ago.

A rate hike this week would mark the Fed's first tightening since July 2023, when it raised the fed funds rate to 5.25-5.50% and then held steady through more than two years of disinflation. Interest-rate swaps imply a roughly 37% chance of a quarter-point increase at this meeting, with traders fully pricing a hike by September. Virtually all economists surveyed by Bloomberg expect the Fed to keep rates unchanged this week.

The inflation calculus has shifted dramatically in recent weeks. Brent crude breached $100 a barrel as Middle East tensions escalated, with President Donald Trump saying he is considering a "massive attack" on Iran. The rebound in oil prices has clouded the inflation outlook just as the Fed was gaining confidence that price pressures were contained. June's inflation data likely understates July's pressures, as gasoline prices have rebounded to recent highs.

The cross-asset transmission has been unambiguous. Rising real yields have strengthened the dollar, with the DXY index pushing higher against major peers. The Treasury curve has flattened as short-duration yields rose more sharply than long-duration yields, reflecting expectations that any tightening would be short-lived. The last time the Fed faced a similar energy-driven inflation scare was in mid-2022, when Brent averaged $110 a barrel and the central bank delivered 75-basis-point hikes over four consecutive meetings.

For EUR/USD, the stakes are particularly high. The euro has weakened against the dollar this month as the rate differential between the Fed and the European Central Bank has widened. If the Fed delivers a hawkish hold — keeping rates unchanged but signaling a September hike — the dollar could strengthen further, pushing EUR/USD below 1.13. If the Fed strikes a dovish tone or acknowledges that the energy shock may be transitory, the euro could rebound toward 1.15.

The policy decision is scheduled for 2 p.m. Eastern time Wednesday, followed by Warsh's press conference at 2:30 p.m. The Bank of Japan begins its own policy meeting July 30, adding another layer of currency market complexity as the carry trade dynamics between the dollar and yen shift.

This article is for informational purposes only and does not constitute investment advice.