Why has the dollar strengthened recently, and why is BofA sticking to its view?

  • The dollar has appreciated over the past 1–2 months, with the DXY index at one point reaching its highest level since shortly after “Liberation Day.” BofA still considers the dollar moderately overvalued, maintains its view of modest medium-term weakness, and expects the US midterm elections to have a limited lasting impact on the dollar.
  • Interest rates have supported this rally: US growth data have been relatively strong, inflation has remained sticky, and September CPI exceeded expectations as price pressures broadened across core components. US Treasury yields rose around the Federal Reserve’s September rate hike, and yield spreads shifted in the dollar’s favour; the overnight index swap market has priced in three more hikes by mid-2027.
  • Middle East turmoil continues to support the dollar through energy prices. Even though the September employment report fell short of expectations, broader indicators still show a resilient labour market, so recent data have not provided a direct impetus for dollar weakness.

What conditions are needed for a medium-term decline, and how do technology stocks affect the dollar?

  • BofA’s forecast for dollar depreciation depends partly on two possible paths: the Federal Reserve being unable to raise rates beyond current market pricing, or Middle East tensions eventually easing and pressure on energy markets abating. If inflation remains sticky or oil prices rise, the dollar faces further upside risk.
  • Turmoil in AI and technology has slowed the dollar’s rise. If US technology stocks continue to sell off and undermine the notion of “US exceptionalism,” BofA believes the dollar could give back more of its recent gains.
  • The dollar-weakness view coexists with forecasts for relatively high Treasury yields: BofA still expects the US 10-year Treasury yield to be 5.00% at the end of 2026 and 4.75% at the end of 2027. Its exchange-rate reasoning does not rely on a sharp fall in Treasury yields.

Why can a euro recovery not bypass French fiscal risks?

  • According to BofA’s estimates of moves from 9 September to 16 October, the widening French-German 10-year government bond spread explained about 60% of the decline in EUR/USD, with the rest possibly attributable to changes in two-year spreads. The bank’s empirical relationship suggests that each 10-basis-point widening of the French-German 10-year spread typically corresponds to an approximately 0.4% depreciation in EUR/USD.
  • BofA remains bullish on the euro at current pricing of French risk, assuming the French budget passes before December; its rates team expects the French-German 10-year spread to trade between 100 and 150 basis points. Budget progress and political risks therefore directly affect the scope for a euro recovery.
  • Energy remains a near-term constraint: BofA assumes no Iran deal will be reached before the midterm elections. Although eurozone data have been better than previously feared, positive surprises may have peaked; the bank is not bullish on the euro across the board and remains bearish on EUR/GBP.

Which specific forecasts are unchanged, and which have been cut?

  • BofA maintains its EUR/USD forecasts of 1.15 at the end of 2026 and 1.20 at the end of 2027, above the Bloomberg consensus medians of 1.14 and 1.17, respectively; the report used a spot rate of 1.12 on 20 October. Its expectation for a euro recovery is stronger than consensus.
  • The direction of yen appreciation is unchanged, but BofA has raised its end-2026 USD/JPY forecast to 152, lowering its expectation for near-term yen strength. The spot level at the same time was 158, and the end-2027 forecast is 145. Forecasts for the Australian and New Zealand dollars were also cut, while those for other European currencies and the Canadian dollar remained unchanged.