The dollar is seeing a downturn as European morning trade gets underway, continuing its declines from the previous week. The EUR/USD pair is approaching the 1.1800 level, up by 0.3% to 1.1797, indicating potential for further gains.
However, significant option expiries around this level may restrict progress until US retail sales data is released. Other currencies show similar trends, with USD/JPY dropping 0.4% to 146.72 and GBP/USD rising 0.3% to 1.3638.
The Focus On A Weaker Dollar
The focus on a weaker dollar is increasing and may pose a key risk if the Federal Reserve adopts a dovish stance in its upcoming communication.
The dollar weakness we’re seeing is setting the stage for tomorrow’s pivotal Fed meeting. Recent data supports this dovish shift, with the August 2025 inflation report showing CPI cooling to 2.8%, missing expectations and marking the third consecutive monthly decline. This gives the Fed room to signal that its tightening cycle, which began back in 2023, is definitively over.
For traders looking at EUR/USD, the test of 1.1800 is critical. Given the backdrop, buying out-of-the-money call options with an expiry in the coming weeks could be a calculated way to play a breakout above this level, especially if the Fed confirms a softer stance. This strategy positions for a potentially sharp upward move while defining risk, mindful that large option expiries may keep it pinned in the very short term.
In the case of USD/JPY, the slide towards 146.00 reflects the market anticipating a narrowing of interest rate differentials. We can look to purchase put options to capitalize on further downside in the pair if the Fed comes across as more dovish than expected. This trend is also supported by the Bank of Japan’s gradual policy normalization throughout 2025, which has provided underlying strength to the yen.
Increased Volatility Around Fed Pivot
The key takeaway for the next few weeks is that volatility is likely to increase around this Fed pivot. Traders could consider volatility plays, such as buying straddles on major pairs like EUR/USD, which would profit from a significant price move in either direction following tomorrow’s announcement. This is a prudent approach given that the market reaction to a policy shift is often more pronounced than the initial signal itself.
We have seen this pattern before during previous Federal Reserve policy shifts, like the one that occurred in late 2023 when signals of an end to rate hikes led to a multi-month slide in the dollar index. The current economic data, particularly the recent miss in the August non-farm payrolls which came in at only 150,000 jobs, suggests a similar environment is now taking hold. This historical precedent reinforces the view that we may be at the start of a longer-term trend of dollar depreciation.
