Central banks put currencies back in the driving seat
Market overview
Global currency markets are once again taking their lead from central banks, interest-rate expectations and the credibility of inflation policy. The Federal Reserve’s decision triggered a pullback in the dollar as heavily crowded hawkish positions were unwound, while rising longer-dated Treasury yields highlighted persistent concerns over inflation and fiscal risk. Attention now shifts to the Bank of England and a busy eurozone data calendar, leaving sterling and the euro exposed to fresh volatility. With energy prices, bond markets and incoming inflation figures all pulling in different directions, FX trading is likely to remain highly sensitive to changes in policy expectations.
USD: Crowded hawkish bets unwind
The Federal Reserve left interest rates unchanged at 3.50% to 3.75%, with the decision passing by seven votes to three. Three policymakers backed an increase, marking a clear shift from June’s unanimous decision to hold.
Despite the more hawkish vote split, the dollar and two-year Treasury yields moved lower. Investors had already positioned heavily for a restrictive outcome, leaving a high threshold for any further upside in the currency. Short positions in SOFR and federal funds futures remain close to record levels, reinforcing the sense that much of the hawkish risk had already been priced in.
The lack of updated forecasts, a new dot plot or a meaningful change in the policy statement limited the scope for a stronger reaction. Around nine basis points of tightening had also been priced into the meeting, creating the conditions for a sharp reversal once the Fed failed to exceed expectations.
Further along the Treasury curve, yields rose as inflation concerns returned to the foreground. Thirty-year yields reached their highest level since 2007, driven largely by higher inflation expectations rather than rising real yields.
The Fed maintained a restrictive tone while preserving flexibility ahead of further data. For now, the DXY is likely to remain within its recent 100.500 to 101.500 range. The next major test will be the July US inflation report on 12 August.
GBP: Bank of England guidance holds the key
The Bank of England takes centre stage, with sterling facing its most important domestic event in several weeks. An unchanged rate decision is widely expected, placing greater importance on the vote split, revised economic forecasts and Governor Bailey’s guidance.
The policy backdrop remains finely balanced. Higher oil and gas prices have increased inflation risks, but domestic indicators have weakened. Wage growth is slowing, inflation expectations have eased and activity data suggest the economy is losing momentum. This gives the Monetary Policy Committee scope to retain a cautious approach while continuing to monitor the impact of energy costs.
Markets will focus closely on whether support for higher rates broadens beyond Megan Greene and Huw Pill. A third vote for an increase could signal that the Committee is moving closer to tightening at a future meeting, potentially supporting sterling through higher UK rate expectations.
A firmer stance could also reassure gilt investors that the Bank remains committed to controlling inflation. By contrast, limited concern over energy-driven price pressures may raise fears that inflation will remain above target for longer, pushing gilt yields higher without providing the pound with the usual support.
Positioning continues to show some demand for protection against sterling weakness, while GBP/EUR has fallen during nine of the past ten sessions. GBP/USD has received some support from the broader dollar retreat following the Fed decision.
A neutral seven-to-two vote and limited forward guidance could still produce a relief rally if traders choose to close defensive positions. However, a clearer hawkish shift would offer the strongest case for sustained sterling gains.
EUR: Data provides the next test
EUR/USD advanced to its highest level since mid-July after the Federal Reserve failed to deliver the hawkish surprise some investors had expected. The pair moved more firmly into the 1.14 region as US rate expectations and dollar positioning returned as the dominant drivers.
Interest-rate differentials have regained influence over the pair, while recent geopolitical developments have produced a more limited currency reaction. Oil prices have rebounded sharply following their steepest three-day decline since 2020, but the euro has remained relatively resilient.
Further gains will depend on both US and eurozone data. A softer July US inflation reading, combined with signs of reduced geopolitical tension, could provide the conditions for a more convincing move above 1.15.
The immediate focus is on preliminary July inflation figures from Spain and Germany, alongside second-quarter GDP estimates for France, Germany and the wider euro area. Stronger-than-expected inflation or growth data should offer additional support to the single currency, particularly if US figures continue to disappoint.
Looking ahead
Bank of England decision: Watch the vote split, inflation forecasts and Governor Bailey’s guidance.
Eurozone inflation: Preliminary figures from Spain and Germany will shape near-term ECB expectations.
Eurozone growth: Second-quarter GDP releases will provide a clearer view of regional momentum.
US inflation: The July report on 12 August is the next major catalyst for the dollar.
Bond markets: Further selling in longer-dated Treasuries could increase volatility across global FX.
Key levels: DXY remains centred on 100.500 to 101.500, while EUR/USD faces resistance near 1.15.