Will the Eurodollar break out of its trading range?

As the Federal Reserve cut interest rates for a third time in December, the Eurodollar traded toward the upper bound of the sideways channel, where it had been stuck since the summer. Futures markets now anticipate at least two additional rate cuts in 2026, contingent on cooling inflation, a continued softening of the labour market and the end of Chair Powell’s term in May 2026. Each 25-bp cut narrows the rate differential with the euro, eroding the interest rate premium that supported the greenback in 2022–2023.

Market projections for the exchange rate in 2026 are broadly split into two camps. One group expects renewed dollar strength on the assumption that US growth re-accelerates, driven by expansionary fiscal policy, deregulation and positive wealth effects. Under this scenario, the Fed would deliver fewer rate cuts than currently priced by the market. The other group expects the narrowing yield gap to drive the pair higher, assuming the ECB holds steady while the Fed eases.

Ultimately, the identity of the next Fed chair may prove to be the most critical variable. At the time of writing, President Trump has yet to announce his nominee. Without this input, the market currently sees aggressive cuts as unlikely, given above-target inflation. This view could shift, however, once we have a clearer picture of the composition of the Federal Reserve’s board in 2026. In addition, expectations regarding the impact of German fiscal spending are currently subdued, since the market has been disappointed by the delay in implementation, and could easily be revised upward as data are reported over the course of 2026. This could lead to further compression in the interest rate differential, thereby providing additional support for a higher EUR/USD exchange rate.

_{Date of report: January 7th 2026}