AI jitters shake markets as the dollar loses momentum

Market overview

Growing unease over artificial intelligence valuations is reshaping sentiment across global currency markets, as investors trim exposure to US technology stocks and seek more defensive opportunities. The shift is driving demand for government bonds, pushing Treasury yields lower and challenging the dollar's ability to capitalise on strong economic data. Sterling continues to benefit from expectations of higher UK interest rates, while the euro faces persistent pressure from France's deepening fiscal troubles. With risk appetite becoming increasingly selective, traditional safe-haven currencies are gaining favour over their commodity-linked counterparts.

The broader market picture reflects a delicate balance between persistent inflation and mounting concerns over economic growth. Elevated energy prices and geopolitical uncertainty continue to underpin expectations of tighter monetary policy, yet volatility in technology shares is increasingly influencing bond yields and currency flows. With major central bank decisions approaching and investors reassessing crowded positions, FX markets face a period of heightened sensitivity to shifts in sentiment.

USD: Strong fundamentals struggle against AI uncertainty

The dollar is finding little reward from a resilient US economy as technology sector volatility and falling Treasury yields undermine its interest rate advantage. Strong inflation and retail sales figures briefly lifted the Dollar Index to a 2026 high of 102.9, but gains faded as expectations of an imminent Federal Reserve rate increase weakened.

The probability of an October hike has fallen from 45% to 14%, shifting attention towards December, where tightening remains heavily priced. Meanwhile, concerns over AI valuations have encouraged demand for US government bonds, pushing yields lower and limiting dollar strength.

Despite the softer tone, persistent inflation and a relatively firm Federal Reserve outlook should prevent a sustained sell-off. The Dollar Index is testing support around 101.50, with further weakness potentially extending towards 101.25–101.30. For now, consolidation looks more likely than a meaningful correction, with technology stocks and Treasury yields setting the direction.

GBP: Rate expectations underpin sterling strength

Sterling continues to outperform as investors strengthen their conviction that the Bank of England will deliver further interest rate increases. Recent inflation figures have reinforced the case for tighter policy, helping establish the pound as an attractive higher-yielding European currency.

However, the strength of this support may be tested. Much of the latest inflationary pressure stems from elevated energy costs rather than broader domestic price growth, raising questions over how aggressively policymakers will need to respond.

With markets pricing close to four rate increases by July 2027, expectations leave little room for disappointment. Any indication that the Bank of England favours a more measured approach could trigger a reassessment and weigh on sterling.

Nevertheless, the pound retains a favourable near-term outlook, supported by interest rate differentials and persistent euro weakness. GBP/EUR looks set to trade around 1.19, with the forthcoming UK Budget presenting the next domestic test.

EUR: France's fiscal crisis overshadows euro resilience

The euro remains vulnerable as France's worsening fiscal position and political uncertainty continue to unsettle investors. French government bond yields have reached 5% for the first time since 2002, while the spread over German Bunds has widened to approximately 159 basis points, highlighting growing concerns over the country's public finances.

Rising energy costs are adding further pressure, threatening growth and complicating efforts to stabilise government borrowing. With budget negotiations unresolved and political unrest continuing, confidence in French assets remains fragile.

EUR/USD has nevertheless demonstrated resilience, benefiting from reduced exposure to US technology stocks and softer dollar yields. However, this appears more reflective of shifting global positioning than any meaningful improvement in the eurozone outlook.

France's forthcoming sovereign rating review presents another potential catalyst for weakness. Unless fiscal concerns ease, the single currency is likely to remain under pressure, particularly against sterling and traditional safe havens.

Looking ahead

• AI and market sentiment: Technology earnings and investor positioning remain central to global risk appetite, with further weakness potentially driving renewed demand for defensive currencies.

• Federal Reserve: The 28 October decision will test expectations for a December rate increase and could determine whether the dollar can regain momentum.

• US economic data: Jobless claims and flash PMI figures will provide fresh insight into growth, inflation and the outlook for Treasury yields.

• Bank of England: Attention turns to the 5 November policy meeting, where markets will look for confirmation of further tightening.

• France: Moody's sovereign rating review and ongoing budget uncertainty could intensify pressure on the euro and French government bonds.

• UK Budget: Fiscal credibility, borrowing forecasts and debt servicing costs will be closely scrutinised for their potential impact on sterling.