Recently, the market's expectations have heated up for the Federal Reserve to slow down the pace of interest rate cuts after a significant reduction in September, leading to a sustained strengthening of the US dollar. The ICE US Dollar Index, which tracks the basket of exchange rates of the US dollar against the euro and five other major currencies, recorded its largest weekly increase since September 2022 last week. This week, on Wednesday and Thursday, it repeatedly hit a nearly two-month high, on track for a two-week winning streak. As of Thursday, the index has accumulated a 2.2% increase in less than two weeks of October.

Institutions have begun to sound the call for the return of the US dollar's reign. Foreign exchange experts from Crédit Agricole, France's second-largest bank, revealed that recent meetings with clients indicated that the dollar's rise so far in October has led foreign exchange investors to question whether it signifies the return of the "US dollar king." The commentary lists several factors supporting the strengthening of the US dollar:

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The unexpectedly strong US non-farm payroll data for September encouraged the market to reduce expectations for Federal Reserve rate cuts, and after the data release, the relative interest rate appeal of the US dollar has been restored.

The escalation of geopolitical tensions in the Middle East has reignited upward oil prices, creating a tense global environment and dampening risk sentiment, thereby boosting the US dollar as a safe-haven asset.

The improving prospects of Trump's re-election as president have increased the risk of a global trade war, providing support for the US dollar.

Crédit Agricole expects the US dollar to recover further but notes that the US interest rate market's expectation for the Federal Reserve's remaining rate cuts this year has been reduced to less than 50 basis points. The current market pricing and the bank's views are essentially in line, indicating that some of the favorable factors related to the Federal Reserve have already been reflected in currency prices. Therefore, the bank believes that more positive US data and/or further weakening of global risk sentiment are needed to boost the US dollar again.

In contrast to the strengthening of the US dollar, the major currency pair, the euro against the US dollar, has weakened. As of this Thursday, the euro against the US dollar has fallen by about 1.8% in October. The following chart from Deutsche Bank shows that shorting the US dollar has recently become a painful trade.

George Saravelos, head of foreign exchange research at Deutsche Bank, predicted the recent decline of the euro. His idea is that without a global trade shock, the euro against the US dollar should be in the range of 1.10 to 1.05, but it leans towards the lower end of this range. This is consistent with Deutsche Bank's current year-end forecast. If the euro falls to 1.05, it would drop by nearly 4% from Thursday's level.

If a global trade war occurs, Saravelos said that the euro could break below 1.05 and possibly approach parity at 1.0. However, Deutsche Bank's analysis does not assume that an increase in global risk premiums would bring additional bullish effects on the US dollar. Deutsche Bank's foreign exchange forecasts have not yet considered the possibility of the latter scenario, and the bank plans to update these forecasts after the US election.

The Deutsche Bank report points out that relative natural interest rate estimates suggest that the terminal rates of the Federal Reserve and the European Central Bank should be closer to 170 basis points, not the current 130 basis points, or the Federal Reserve's federal funds rate at 3.50% and the European Central Bank's deposit rate at 1.75%. Given that fiscal policy, savings rates, and productivity trends all clearly favor the United States, this conclusion should not be surprising. According to the current beta coefficients, if the front-end interest rate differential widens by another 40 basis points, it would cause the euro against the US dollar to fall to 1.07.The report posits that the ensuing question is whether the European Central Bank's (ECB) interest rates should be neutral or below neutral. It states that, given the recent deterioration in the labor market, there is a concern that Germany, in particular, may fall into a nonlinear recession. Beyond this, the key issue remains the outcome of the U.S. elections and the extent of the trade war. Recent analysis by Deutsche Bank has demonstrated that the direct impact of the U.S. imposing a 10% tariff on Europe should be quite limited in terms of European trade conditions and can largely be offset by a 2% depreciation of the trade-weighted euro, which would cause the euro to fall to 1.05 against the U.S. dollar.