EUR/USD has been on a downward trajectory since September 9, as markets priced in an anticipated Fed rate increase while simultaneously raising the odds of further hikes to come—a dynamic that poses risk to traders betting on a sustained decline in the pair.

The currency pair has fallen nearly 1.6% from its August high, driven largely by a sharp rally in oil prices that has stoked fears of resurgent inflation. This oil-driven surge has fed through to U.S. short-term rates and Treasury yields , which have climbed as investors anticipate the energy rally spilling over into broader price pressures across the economy.

However, inflation-sensitive markets have told a different story.

Inflation breakevens and inflation-linked swap rates have risen modestly since late July and early August, but without the intensity seen in nominal rates. Notably, U.S. 2-year , 5-year , and 10-year

inflation swaps have recently pulled back from their rally, as have shorter-dated breakevens —and crucially, none of these measures have broken out of the ranges they've held for the past two years.

This divergence suggests that traders expecting the Fed to adopt an aggressively hawkish tone and signal additional hikes beyond today's meeting may end up disappointed.

Should that scenario play out, the dollar and U.S. rates could face downward pressure, opening the door for EUR/USD to see increased upside risk rather than the continued weakness bears are anticipating.
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(Christopher Romano is a Reuters market analyst. The views expressed are his own)