Dollar Strength Hinges on Fed's Tightening Path

The US dollar's strength is fragile and dependent on the actions of the Federal Reserve (Fed), according to Commerzbank's Thu Lan Nguyen. The EUR/USD pair has dropped to its lowest level since mid-2025, driven by rising US rate expectations and a higher probability of an October Fed hike than an ECB move.

Nguyen analyzed different Fed scenarios and their impact on the dollar. If the Fed raises rates and signals a willingness to tighten further, the dollar is likely to hold onto its gains. However, if the Fed raises rates but tempers expectations of further near-term hikes, the dollar would weaken moderately.

If the Fed leaves rates unchanged but signals that the next move is likely to come in December, the dollar's reaction will depend on whether the market merely postpones its rate expectations or reassesses the Fed's reaction function and revises its entire expected rate path lower. In this scenario, the dollar could face more substantial downward pressure.

Nguyen notes that even though the dollar strength is fragile, it already appears overstretched relative to developments in the Euro Area-US interest rate differential.