Dollar’s Rebound: Tactical Recovery or Structural Decline?

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Between February and the end of June 2025, the US dollar was under sustained downward pressure, reflecting market expectations of an imminent rate-cutting cycle by the Federal Reserve. However, July brought a noticeable shift in investor sentiment towards the greenback, particularly evident in the final days of the month. The trigger for this reversal was the outcome of the July FOMC meeting and Jerome Powell’s press conference, both of which dampened expectations for near-term monetary easing.

Fed Pushback Lowers Rate-Cut Expectations for September

Just a month ago, Fed Funds Futures were pricing in over a 90% probability of a September rate cut. Following recent communications from the Fed, this probability has fallen to below 50%, prompting a rapid repricing across the rates, bond, and FX markets. As a result, the dollar began an appreciation correction, which could reasonably extend into August. Nevertheless, over the medium term, the US dollar is likely to remain on a weakening trajectory.

The probability of a Fed rate cut in September as priced in by the Fed Funds Futures market; source: Bloomberg.

Short-Term Dollar Strength Driven by Rates

In the short term, the dollar is supported by rising US Treasury yields, adjusted Fed expectations, and broader risk-off sentiment linked to trade and geopolitical tensions. Over the longer term, however, the outlook still points to continued USD depreciation, albeit at a more gradual pace.

From a technical perspective, the key level for the USD Index lies at 100. A break above this threshold could open the way to the 101.5–102 range, which appears to be the natural target for the current rebound.

Trade Policy and Political Pressure Undermine USD’s Reserve Status

Despite this near-term strength, the underlying risks to the dollar are mounting. The probability is rising that the Federal Reserve will eventually bow to political pressure and deliver more aggressive rate cuts. This could lift inflation expectations and undermine the dollar’s relative appeal. The recent rise in EURUSD to 1.18 was driven primarily by USD weakness, rather than euro strength.

The root causes of the dollar’s fragility lie in Washington’s aggressive trade policy. The imposition of steep tariffs weakens the US growth premium, erodes trust in the dollar’s safe-haven status, and raises concerns about the greenback’s role as a global reserve currency. At the same time, President Trump’s escalating attacks on the Fed and its leadership increase fears of political interference in monetary policy.

Three additional rate cuts are expected starting in May 2026, following a likely change in Fed leadership. This could push EURUSD higher towards the 1.23–1.25 range in the months ahead. Should markets lose confidence in the Fed’s independence, the dollar’s depreciation could be significantly deeper.

On a purchasing power parity (PPP) basis, the dollar remains overvalued against the euro, which implies further downside potential for USD over the medium term. Although the ECB has voiced concerns about the euro’s appreciation, it has limited influence on the currency given that the rally is largely USD-driven rather than a result of eurozone fundamentals or policy divergence.

EUR/USD Technical Analysis Signals Deeper Correction

The EUR/USD exchange rate has reached its lowest level since June 11, confirming a technical weakening of the currency pair. On the daily chart, a double top formation is clearly emerging, the activation of which may signal a deeper corrective move to the downside. Notably, in recent days the pair has broken below the lower boundary of a short-term ascending channel, reinforcing the bearish sentiment and suggesting further appreciation of the US dollar against the euro. The current correction could mirror the magnitude of the declines observed in April and May of this year, though a more extensive move cannot be ruled out. Key technical support levels are located around 1.1320 and 1.1100, which may act as potential zones for a pause or reversal in the downward momentum.

The correction in the main currency pair may deepen further. EUR/USD chart, daily interval; source: TradingView.

The current pullback in EUR/USD likely reflects a partial unwinding of short USD positions in the futures market. In recent weeks, positioning data (CFTC) showed extremely negative speculative sentiment toward the dollar. This makes the ongoing USD rebound entirely reasonable in the short term and it may extend further towards the 1.13–1.11 area. However, in the medium term (several months), EURUSD is expected to resume its upward trajectory toward the 1.23–1.25 zone.

Monetary Policy Divergence: ECB Nears End, Fed Set to Ease

It is worth emphasising that monetary policy divergence between the Fed and the ECB is set to widen further. The US is on the cusp of beginning an easing cycle, while Europe is nearing the end of its own loosening phase. This fundamental divergence will likely reinforce medium-term euro strength against the dollar.

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