Dollar Is Moving to the Extreme Horizon

The U.S. Dollar Index (DXY) is down by 0.27% to 103.55 points this week, while the EURUSD has risen by 0.60% to 1.09150, marking its highest level since November 6, 2024, when the Trump-driven rally began. Few anticipated such a rapid strengthening of the Euro, which was largely driven by incoming German Chancellor Friedrich Merz’s announcement of a massive spending plan aimed at bolstering the military and heavily investing in the economy. This initiative will require substantial borrowing, with defense spending exempt from the country’s constitutional debt brake. The German government plans to raise €900 billion, including a €500 billion infrastructure fund. These measures will inevitably push up borrowing costs in Germany and tighten monetary conditions across the Eurozone.

German 10-year benchmark debt yields surged from 2.47% last Wednesday to 2.79%, and then to 2.92% the following day. The EURUSD recorded a 4.10% weekly increase to 1.07880 by Thursday’s close and extended gains by another 4.50% to 1.08470 on Friday. This is the strongest rally since March 2009, a move few believed possible. These developments appear historic, as Germany seeks to reassert its political leadership in Europe. However, relying on massive borrowing to achieve this goal may prove problematic, yet no alternative solutions seem viable at present.

The Euro’s rally is further supported by economic headwinds in the United States. Macroeconomic data indicates a cooling U.S. economy, while recession fears have pressured U.S. stocks lower. The S&P 500 index has declined by 9.6% to 5,550 points, its lowest level since September 8, 2024. The fundamental strength of the U.S. Dollar appears compromised.

Typically, the Dollar strengthens when stock indices decline, but that is not the case this time. Large investors have faced significant losses after making a $63.73 million bullish bet on the Dollar through the WisdomTree Bloomberg US Dollar Bullish Fund (USDU) a few weeks ago. The investment was made at an average EURUSD price of 1.04300. As a result, they closed their positions at a 2–4% loss last Wednesday, selling USDU shares for $49.15 million at EURUSD prices ranging from 1.06200 to 1.07700. This liquidation resulted in 77% of long Dollar positions being closed at a loss, while the remaining $14.58 million is still in play.

The EURUSD is now under intense overbought pressure, making a correction likely. Strong support could be found at 1.05800–1.06000, where the rally originally began. This week’s U.S. inflation data for February will be crucial. A slowdown in inflation could further encourage the Federal Reserve to consider lowering interest rates, potentially triggering an immediate correction towards 1.06000. However, it would be preferable for the EURUSD to reach its upside targets of 1.09500–1.10500 before pulling back. Given the current situation, betting on further upside appears risky, and short trades could be the more reasonable strategy.