November 25, 2025
Yield Differentials Strengthen the Euro
Developments of the year and a well-founded outlook: Read our experts’ analyses and forecasts on currencies here.
The 2026 Annual Outlook – Currencies
- Dirk Chlench · Strategy / Macro Research
Yield differentials have always been a key factor in the exchange rate relationship between the euro and the U.S. dollar. Although the so-called “Liberation Day” in early April – when the U.S. announced sweeping tariff increases on nearly all its trading partners – temporarily disrupted this dynamic (see left chart), yield differentials have returned as a driver of exchange rate movements in recent months (see right chart) and are central to our forecast.
While the ECB’s spree of interest rate cuts has come to a halt, we expect the Federal Reserve to lower its benchmark interest rate by the end of 2026 two more times by 25 basis points, due to persistent labor market weakness. These divergent monetary policies are expected to reduce the yield advantage of short-term U.S. Treasuries compared to equivalent German Bunds.
Historically, there have been extended periods when the euro-dollar exchange rate diverged from its typical correlation with yield spreads. For instance, the joint initiative by Angela Merkel and Emmanuel Macron to establish a “Recovery Fund” in 2020 – aimed at mitigating the economic fallout of the COVID-19 pandemic – boosted the euro for many months. However, no comparable factor is currently on the horizon. While political uncertainty ahead of the French presidential elections in 2027 may put some pressure on the euro, confidence in the U.S. dollar is also being undermined by Trump’s increasingly autocratic governance. As a result, our euro- dollar forecast will continue to closely track interest rate differentials. By the end of 2026, we expect an exchange rate of $1.22 per euro.
As for the Swiss franc, the interest rate disadvantage compared to the eurozone is likely to cause a slight depreciation against the euro. Nevertheless, the potential for a significant depreciation of the franc remains limited; we do not expect the franc to reach parity with the euro in the near term.
The relationship between interest rate differentials and the U.S. dollar exchange rate broke down temporarily
Euro to U.S. dollar and yield differential
Key questions from clients answered by our experts
Can U.S. economic data still be trusted?
At the end of July, the U.S. President dismissed the head of the Bureau of Labor Statistics after the agency reported a disappointing increase in hiring. Trump accused the head of manipulating the data. However, a comparison of official statistics with the jobs increase reported by payroll service provider ADP shows no significant discrepancies compared to the past. Available data since then is not yet conclusive, but skepticism may be warranted.
Is the dollar's role as reserve currency in danger?
The current U.S. administration sees the U.S. dollar’s role as the global reserve currency more as a curse than a blessing. By attacking the Fed’s independence, it is undermining trust in the dollar itself. However, there are no clear alternatives available. So far, neither the euro nor the yuan has benefited much from this loss of trust. Gold is the winner.
Dirk Chlench · Strategy / Macro Research
The 2026 Annual Outlook – eight topics in focus
The 2026 annual outlook – PDF download
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3.3 MB | 25.11.2025
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