Euro: Fed repricing supports moderate gains against US Dollar – Commerzbank

Commerzbank’s Thu Lan Nguyen argues that the US Dollar's (USD) current support from perceived hawkish Federal Reserve (Fed) policy is likely to fade as markets reassess United States (US) rate expectations over coming quarters. While Euro (EUR) upside is seen as limited due to energy-related growth and rate headwinds, EUR/USD is still forecast to grind higher towards 1.19 by end-2027 as US rate expectations ease.

Dollar strength seen moderating

"The US dollar is currently benefiting from a Federal Reserve that markets continue to perceive as relatively hawkish. However, this narrative has shown the first signs of cracking since the July FOMC meeting. Despite this, markets still price in further US rate hikes."

"We believe these expectations are overly optimistic and expect a reassessment of the rate outlook over the coming quarters, which should weigh on the dollar. While ECB rate expectations also appear somewhat stretched, the euro is likely to benefit more than the US currency from a resolution of the US-Iran conflict."

"If, as we expect, tensions between the US and Iran continue to ease towards year-end, inflationary pressures should moderate considerably next year. In that environment, the Fed could once again shift its focus towards supporting growth and eventually even resume its rate-cutting cycle."

"We therefore expect US rate expectations to be revised materially lower over the coming quarters, a development that should ultimately weigh on the dollar. However, the depreciation is unlikely to be quite as pronounced as we had previously assumed as we have to acknowledge that the risk that the Fed will hike rates in the coming months after all has increased. We now see EUR/USD at 1.19 (previously 1.21) at the end of next year."