2% Fed target in 2027: What will change the US Dollar's course as inflation eases towards that level?

The US Dollar (USD) is navigating a retreat in crude Oil towards $90/bbl. The macroeconomic narrative is changing as markets shift their attention between near-term Federal Reserve (Fed) policy expectations, energy prices and underperforming equities. Resilient domestic activity and attractive yield carry still underpin the Greenback. Yet lower US Treasury yields and weaker Oil prices are challenging its standing as an effortless safe haven. With a December Fed rate hike still largely priced in, investors are assessing incoming inflation data. Strategists at ING, TD Securities, and MUFG differ on whether the latest US Dollar weakness is a modest year-end consolidation or the precursor to a wider cyclical turn in 2027.

Q1 2027: ING sees hawkish Fed underpinning US Dollar before Q2 inflation retreat

Inflation above 3% should help sustain near-term US Dollar support, according to Chris Turner at ING. Alongside strong US growth, persistent price pressures are expected to keep the Federal Reserve signalling further tightening through the first quarter of 2027. ING nevertheless sees a distinct shift in the second quarter. Base effects should bring headline inflation back towards the Fed's 2% target, pushing short-dated US 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 haven demand subdued as equity signals turn bearish, TD Securities says

Limited US Dollar gains during recent global equity sell-offs suggest it no longer functions as an effortless safe haven, argue Jayati Bharadwaj and the macro strategy team at TD Securities. Resilient US growth and attractive carry remain supportive. However, US equities' relative underperformance and Fed hawkishness already reflected in prices point to modest Greenback weakness into year-end. Euro weakness associated with French debt risks should constrain the scale of overall USD losses.

"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 weakens as lower yields and Oil relieve Fed pressure, MUFG says

Lower Brent crude prices and US Treasury yields are easing pressure on the Federal Reserve, according to Lee Hardman at MUFG. Against that backdrop, the US Dollar has surrendered its post-payrolls advance. Markets still price in a December rate hike, but traders are reducing expectations for further tightening in 2027 ahead of crucial CPI inflation figures.

"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."

2027 policy outlook limits US Dollar upside

US Dollar direction hinges on the balance between a resilient domestic economy and waning monetary policy momentum for 2027. Inflation above 3% and a hawkish Federal Reserve should provide firm Greenback support through the first quarter, in the view of ING. By contrast, the analysis from TD Securities and MUFG shows that subdued safe-haven demand, easing energy-related yield pressures and reduced expectations for 2027 rate hikes are restricting gains. Together, these factors leave the US Dollar positioned for a broader slowdown as inflation approaches target.

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