Euro: Credibility restored supports Dollar – Commerzbank

Commerzbank’s Thu Lan Nguyen notes that the Fed’s unanimous September rate hike has temporarily restored its credibility and supported the Dollar, prompting a lower EUR/USD year-end forecast to 1.15 from 1.17. However, they expect both US and euro area rate expectations to be revised down over 2027, ultimately weighing more on the US Dollar (USD) than the Euro (EUR) and allowing EUR/USD to gradually rise.

Fed credibility and shifting rate path

"As we expect the Fed to deliver one additional rate increase before year-end, major doubts about the central bank’s credibility are unlikely to resurface in the near term. We have therefore lowered our EUR/USD forecast for year-end from 1.17 to 1.15. Previously, we had expected the Fed to leave rates unchanged."

"For next year, however, we maintain our view that the Fed will not tighten monetary policy as aggressively as markets currently expect. Assuming the crisis in the Middle East gradually subsides, as we anticipate, the current inflation shock should also fade over the course of next year, eliminating the need for further rate hikes. In fact, we see a good chance that the Fed will cut rates by the end of 2027."

"We expect only one further rate hike in December, followed by unchanged rates through the end of 2027."

"As a result, a downward adjustment in euro area rate expectations is also likely to weigh on the euro next year. Why, then, do we still expect EUR/USD to rise over the course of 2027?"

"Consequently, the dollar is likely to face pressure not only from a downward revision of US rate expectations, but also from renewed concerns that Fed independence is being undermined by the White House. We therefore expect the dollar to come under greater pressure than the euro in the end, despite likely downward revisions to rate expectations on both sides of the Atlantic."

"Nevertheless, if relations between Iran and the US continue to improve, and energy prices consequently fall sharply, EUR/USD could well come under further downward pressure. However, we would not view any resulting dollar strength as sustainable."