Commentary: Why the Dollar’s Recent Strength Is Built on Shaky Ground

Since October 6, the U.S. dollar has experienced a marked strengthening, peaking intraday at 99.6 on October 9, the highest level since early August. This raises questions about whether the dollar can break its previously observed low-range volatility since the third quarter and if projections of long-term decline remain valid[para. 1].

The dollar’s recent surge followed the Federal Reserve’s mid-September rate cut and can be divided into three distinct phases, primarily driven by two core factors[para. 2]. In the first phase (September 17–25), after the Fed reduced rates by 25 basis points, the accompanying economic forecast was more neutral-to-hawkish than markets expected. The Federal funds target was set at 4.00%-4.25%, with hints of another 50 basis points of cuts this year. However, positive data such as the upward GDP revision to 3.8% and dropping jobless claims caused investors to reassess their outlook—reducing rate cut expectations for 2025. Concurrently, the 2-year Treasury yield and the dollar index both climbed, with the dollar index up 2.1% to 98.6 and the 2-year yield at 3.64%[para. 3].

The second phase (September 26–October 3) saw gains pause as the threat, then reality, of a U.S. government shutdown loomed. Both the dollar and Treasury yields dropped; by October 3, the dollar index fell to 97.7 and the 2-year yield dipped to 3.58%[para. 4].

In the third phase (October 6–9), the dollar’s ascent was spurred by international political turmoil. In Japan, Sanae Takaichi’s unexpected elevation led markets to expect policies aligned with "Abenomics," weakening the yen. Simultaneously, France’s political instability—marked by Prime Minister Sébastien Lecornu’s resignation—caused the euro to tumble. These external factors propelled the dollar higher, reaching 99.6, while Treasury yields remained largely unchanged[para. 5].

However, the rally may be fleeting. On October 10, the dollar weakened again after President Donald Trump announced a planned 100% tariff on Chinese goods. The recent surge is viewed as a counter-trend rebound rather than the start of a sustained rally, with several factors likely precluding further appreciation even absent escalating trade conflicts[para. 6].

The first such factor is that early October’s dollar gains weren’t anchored in U.S. economic fundamentals; key data was delayed by the shutdown, and other indicators like the PMI and ADP reports showed no decisive trends. Though the economy is resilient, the Fed’s actions hinge on job market weakness, which will take time to confirm[para. 7]. Second, the protracted government shutdown could soon pressure the dollar, especially as Congressional compromises are needed by mid-October[para. 8].

Third, political shocks in Japan and France are seen as one-time events with limited lasting market impact, and much of their effects have been priced in already. Lecornu was reappointed as France’s prime minister on October 10, signaling some stabilization[para. 9]. Fourth, prospects for renewed U.S.-China trade conflict present new headwinds for the dollar[para. 10].

While risks remain of both sharper depreciation (should the trade war or shutdown worsen) or a more sustained rally (should U.S. labor markets remain strong and tariffs prove inflationary), consensus sees the rebound nearing its end. Markets are pricing in four to five Fed rate cuts by end-2026, but expectations of two to four are deemed more realistic; in a zero-rate-cut scenario, the dollar index could stabilize around 102[para. 11-12].

In the broader picture, the dollar may have entered the early phase of a major depreciation cycle, echoing past cycles marked by volatility and intermittent rallies. The decisive drivers for a substantial break lower would be substantive policy shifts such as fiscal tightening, new recessions, or unexpected actions in major economies. However, factors favoring dollar strength, such as U.S. technological leadership, remain potent counterweights[para. 13].