Over the past decade, analysis of the EUR/USD currency pair has revealed a consistent pattern: deviations of approximately +/-5% from its short-term financial fair value. This fair value is largely dictated by interest rate differentials between the Eurozone and the United States. Forecasting the EUR/USD exchange rate, therefore, necessitates accurately predicting the timing and magnitude of these risk premiums.
Our economists and trade experts project a peak risk premium to be factored into the EUR/USD valuation around the period of 4Q25 to 1Q26. This timeframe is strategically chosen based on the anticipated actions of a potential future Trump administration. Drawing parallels with the trade policies enacted against China in 2018, it is expected to take roughly a year for a new administration’s trade team to initiate trade investigations through the WTO or conduct internal inquiries at the US Trade Representative.
This 4Q25/1Q26 window could represent a period of maximum pressure for Europe. A Trump administration might aggressively pursue trade concessions from Europe, while concurrently, tight financial conditions, potentially marked by US ten-year Treasury yields as high as 5.50%, could exacerbate the risk-averse environment. This combination would further weigh on the pro-cyclical EUR/USD pair. Our European economic team anticipates that significant, cohesive fiscal support measures for European domestic demand are unlikely to materialize until later in 2026, adding to the pressure during this period.
Synthesizing the dynamics of interest rate differentials and the projected risk premium paints a picture of a weakening EUR/USD over the next two years. Current projections suggest the pair will likely be testing parity levels by late 2025.
However, this EUR/USD forecast is subject to upside risks. A significant positive surprise could emerge if policymakers in China or Europe were to implement substantial fiscal stimulus measures. For instance, a proactive new German government, as previously discussed in our analysis of potential German political shifts, could play a pivotal role in revitalizing global demand trends. Alternatively, a sharp decline in demand for US Treasuries, potentially triggering financial instability and subsequent easing of Federal Reserve policy rates, could also provide upward pressure on the EUR/USD.
Conversely, downside risks to this forecast, particularly extending into 2026, are primarily rooted in the possibility of a Eurozone recession. Such a downturn could be triggered by the imposition of tariffs, creating a highly unfavorable climate for investment. In a recessionary scenario, the European Central Bank (ECB) might be compelled to implement more aggressive interest rate cuts than currently anticipated, further weakening the euro against the dollar.
