Morgan Stanley: Euro Could Surge Past 1.30 on Hedging Flows

The euro may still have significant room to rise against the U.S. dollar, according to Morgan Stanley. In a recent client note, the bank’s strategists projected that EUR/USD could break above 1.30, which is driven by accelerated currency hedging among European investors. The outlook surpasses Morgan Stanley’s already bullish 2026 year-end forecast of 1.27.

European Hedging Activity Gains Momentum

The euro has rallied nearly 12% so far in 2025, supported by a combination of increased European Union spending on defense and infrastructure and growing uncertainty over U.S. fiscal and trade policy. As volatility surrounding President Trump’s economic agenda intensifies, traditional safe-haven demand for the dollar appears to be fading.

This shift has prompted European pension funds and insurers to hedge their exposure to dollar-denominated assets. According to Morgan Stanley estimates, European investors currently hold around $8 trillion in U.S. stocks and bonds, but approximately $3.6 trillion of that remains unhedged.

Even a small change in hedging behavior could trigger substantial capital flows. The bank forecasts that European investors may move to hedge an additional $400 billion over the next year, which could fuel further euro strength. Morgan Stanley strategists, led by David Adams, believe this could push the euro another 7% higher from current levels.

Lower Hedging Costs Encourage Action

Another key driver behind the potential euro rally is the decreasing cost of currency hedging. The Federal Reserve is expected to begin cutting interest rates, starting with a 25 basis point reduction in October. As a result, the cost of hedging dollar exposure is becoming more attractive for long-term investors.

This trend makes it more economical for European funds to protect against dollar risk while seeking stability amid rising global market volatility.

ECB Policy Takes a Back Seat

While the European Central Bank remains cautious about future rate decisions, Morgan Stanley believes that hedging flows and capital management strategies are now outweighing traditional short-term interest rate differentials.

Institutional investors appear to be prioritizing currency protection and risk mitigation over yield advantages. According to the bank, this could fundamentally reshape the EUR/USD landscape over the coming quarters, potentially driving the currency to levels not seen since early 2014.

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