"Trump Trade" is making a comeback, with expectations rising for consecutive rate cuts by the European Central Bank. Will the euro fall back to parity against the US dollar?

Recently, the euro has been caught in a double dilemma, dragged down by the European Central Bank's interest rate cuts and Trump's tariff agenda, causing the euro to fall to parity with the dollar and the risk of depreciation to suddenly rise, leading to a surge in demand for options to hedge against euro devaluation.

On Friday, the euro to dollar exchange rate was around 1.0850, poised for a third consecutive week of decline, marking the longest downward trend since June.

The euro also hit its lowest level against the pound since 2022. The bearish sentiment towards the euro is more pronounced in the options market, with traders increasing their bearish bets on the euro. Currently, the risk reversal index for the euro against the dollar is the most negative in nearly three months.

Wall Street is also bearish on the euro, with Pictet and Deutsche Bank no longer seeing the euro reaching parity with the dollar as a distant possibility. Meanwhile, J.P. Morgan Private Bank and ING believe that the euro could fall to that level by the end of the year. Michael Hart, Senior Currency Strategist at Pictet Wealth, stated:

If Trump wins and imposes tariffs aggressively, achieving parity between the euro and the dollar is definitely possible.

Euro Facing Double Dilemma

Following the European Central Bank's interest rate cut this week, and the financial markets realizing the potential for global trade conflicts if Trump becomes president, the risk of the euro falling to parity with the dollar is increasing, leading to a sharp decline in the euro.

Specifically, earlier this week, Trump mentioned in an interview with Bloomberg that tariffs are "the most beautiful word in the dictionary." He specifically mentioned Europe, saying, "You know what's the hardest to deal with? The EU. They treat us so badly, we have a deficit."

Kaspar Hense, Senior Portfolio Manager at BlueBay Asset Management, stated:

If Trump is elected and a tariff conflict is imminent, this may force the ECB to take further action to keep the euro weak and competitive.

At the same time, ECB President Lagarde warned that any barriers would bring "downside risks" to the struggling EU economy. On Thursday, she announced a second consecutive rate cut, sparking market speculation of further significant rate cuts in the future.

The money market expects a 30% chance of a 50 basis point rate cut at the ECB's final meeting of the year, and it is already fully anticipated that there will be 25 basis point cuts at subsequent meetings.

Pessimism Spreading in the Options Market

It is worth noting that pessimism in the options market is becoming evident, with traders increasing their bearish bets on the euro.

The risk reversal index for the euro against the dollar, which measures the cost difference of options on the currency pair's rise and fall in the next month, is the most negative in nearly three months, indicating a market preference for betting on the euro's decline.

According to data from custody trusts and clearing companies, short-term options to hedge against euro weakness are mainly concentrated in the range of $1.08 to $1.07, interest in protective options for the euro falling to $1.05 is rising, and the proportion of options for parity trading in total trading volume remains relatively small