US Dollar faces a potential change of course as inflation eases towards the Fed’s 2% target in 2027

The US Dollar (USD) faces a changing macroeconomic backdrop, with crude oil prices retreating towards $90/bbl and US Treasury yields declining as attention shifts between near-term Federal Reserve (Fed) policy expectations, energy markets and equity underperformance. Resilient domestic activity and attractive yield carry continue to underpin the greenback, although its standing as an effortless safe haven is coming under scrutiny. With a December Fed rate rise still largely priced in, investors are assessing incoming inflation readings, while institutional strategists at ING, TD Securities, and MUFG consider whether the dollar's current weakness is merely a modest year-end consolidation or signals a wider cyclical turning point in 2027.

US Dollar to Retain Support Into Q1 2027 Before Q2 Inflation Decline, ING Expects

Inflation remaining above 3%, alongside robust US growth, should keep the Federal Reserve signalling the possibility of further tightening through the first quarter of 2027, according to Chris Turner at ING. This underpins his positive near-term dollar outlook. ING nevertheless expects a distinct shift in the second quarter, when base effects bring headline inflation back towards the Fed's 2% target and push short-dated US interest rates lower.

"The dollar should stay supported by strong US growth, high inflation and a Fed threatening to tighten before weakening next spring as inflation falls... Our base call assumes that the Federal Reserve stays hawkish in the first quarter, as decent US growth and above-3% inflation keep money markets pricing in the threat of an extended tightening cycle... That turns in the second quarter, when energy-driven base effects drop out of headline inflation and a return to the Fed’s 2% inflation target sees short-dated US rates move meaningfully lower."

US Dollar's Haven Appeal Fades as Equity Factors Turn Bearish, TD Securities Says

The dollar's limited gains during recent bouts of global equity risk aversion suggest it no longer functions as an effortless safe haven, according to Jayati Bharadwaj and the macro strategy team at TD Securities. Although resilient US growth and appealing carry continue to provide a foundation of support, US equities' relative underperformance and already-priced-in Fed hawkishness point to modest dollar losses towards year-end. Weakness in the euro arising from French debt risks should, however, constrain the USD's overall decline.

"We continue to see US vs RoW relative equity performance as the main driver for the broad USD. Muted USD upside despite equity risk-off last week confirms our view that the USD is no longer the effortless haven currency it used to be... While we expect some modest USD downside into year-end, the magnitude will likely be muted as the EUR remains impaired by the French debt fragility... USD still benefits from a supportive external balance backdrop, a US economy that remains resilient, and its attractive carry profile. However, Equity factor has turned bearish USD."

US Dollar Softens as Lower Yields and Oil Prices Relieve Fed Pressure, MUFG Notes

Falling Brent crude prices and US Treasury yields are easing pressure on the Federal Reserve, with the dollar having surrendered its post-payrolls advance, notes Lee Hardman at MUFG. A December interest rate rise remains priced into financial markets. Ahead of crucial CPI inflation figures, however, traders are reducing their expectations for further monetary tightening in 2027.

"The US dollar has continued to trade at weaker levels overnight after giving back all of its gains yesterday following the release of the stronger NFP report on Friday... The move lower in energy prices is also helping to bring down government borrowing costs... If there is further progress towards a US-Iran deal to end the conflict it would help to sustain lower energy prices and ease pressure on major central banks including the Fed to keep hiking rates... The US rate market still expects the Fed to hike rates again as planned at the end of this year in December but has been scaling back expectations for further hikes in 2027."

US Dollar Support Faces Easing Policy Momentum

Resilient domestic activity continues to support the dollar, but diminishing monetary policy momentum for 2027 is pulling in the opposite direction. Inflation above 3% and a hawkish Federal Reserve should provide firm backing through the first quarter, in the view of ING. By contrast, TD Securities and MUFG highlight constraints on further gains: subdued safe-haven demand, easing energy-related pressure on yields and reduced expectations for 2027 rate rises. Together, these factors leave the dollar positioned for a broader slowdown as inflation moves back towards target.

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)