Dollar holds firm as euro slides and sterling targets fresh highs
Market overview
Currency markets are navigating an increasingly difficult landscape as rising bond yields, geopolitical tensions and mounting fiscal concerns reshape investor positioning. The dollar remains firmly in favour, supported by attractive US yields and renewed demand for defensive assets, while the euro continues to struggle under the weight of political and fiscal uncertainty in France. Sterling has emerged as a relative outperformer, particularly against the single currency, although its progress against the dollar remains limited. With global equities retreating from record highs and volatility beginning to return, investors are becoming more selective about where they seek both yield and stability.
The wider macroeconomic picture offers little immediate relief. Oil prices are climbing again as tensions involving Iran threaten energy supplies, adding to inflation concerns just as central banks attempt to regain control of price pressures. Meanwhile, last night's Federal Reserve minutes reinforced expectations that US monetary policy could tighten further, with Treasury yields holding at elevated levels. Across Europe, widening sovereign bond spreads are undermining confidence in the eurozone outlook, leaving FX markets increasingly sensitive to political developments, interest rate expectations and changes in risk appetite.
USD: Higher yields keep the dollar in control
The dollar continues to benefit from a powerful combination of monetary policy expectations, elevated Treasury yields and safe-haven demand. Last night's FOMC minutes reinforced the Fed's determination to tackle persistent inflation, with policymakers suggesting financial conditions may still be too accommodative. Despite last month's anticipated rate increase, the prospect of further tightening before year-end remains firmly in focus.
US 10-year Treasury yields remain above 5.3%, strengthening the dollar's appeal as investors reassess the outlook for interest rates. Renewed tensions involving Iran have also pushed energy prices higher, complicating the inflation outlook and supporting expectations that borrowing costs could remain elevated for longer.
With equities losing momentum and European currencies facing their own challenges, the dollar remains well positioned. A meaningful reversal will likely require either softer US inflation data or a clear improvement in global risk sentiment, neither of which appears imminent.
GBP: Sterling's European rally meets resistance
Sterling's recent performance highlights a clear divide in currency markets. GBP/EUR has recorded nine consecutive daily advances, an exceptionally rare sequence, as mounting pressure on the euro helped push the pair above 1.18. Some profit-taking has emerged this morning, bringing the cross back below that level, although the broader momentum remains favourable for the pound.
Against the dollar, sterling has found progress considerably harder. GBP/USD continues to trade in the low 1.32s, with its recovery from three-month lows constrained by higher US yields and expectations of additional Fed tightening.
UK government bond yields remain relatively attractive, providing underlying support through carry demand. However, sterling's strength is largely a reflection of deteriorating confidence elsewhere in Europe rather than a significant improvement in Britain's economic prospects.
For GBP/EUR, a sustained break above 1.18 could open the door to further gains, particularly if French fiscal concerns intensify. Nevertheless, the pound's limited recovery against the dollar suggests investors remain cautious about taking a more aggressive bullish position.
EUR: French fiscal turmoil deepens the sell-off
The euro remains under considerable pressure as France's fiscal difficulties increasingly threaten confidence across the wider currency bloc. French government borrowing costs have risen sharply relative to Germany's, with the 10-year yield spread reaching levels last seen in 2011, raising concerns about potential contagion across eurozone sovereign debt markets.
EUR/USD declined more than 0.5% yesterday, approaching the 5 October low of 1.1161 and trading around its weakest levels since May 2025. EUR/GBP also fell to 0.8448, a 16-month low, reflecting the increasingly negative sentiment surrounding the single currency.
Complicating matters further, expectations of additional ECB tightening have faded despite persistent inflation risks from elevated energy prices. Investors are increasingly questioning whether the central bank can justify higher borrowing costs while France struggles with its fiscal position and the broader region faces weaker growth prospects.
The ECB therefore faces a difficult balancing act. Further tightening risks worsening financial pressures, while a more accommodative stance could weaken the euro's yield appeal. Neither outcome offers an obvious catalyst for a sustained recovery.
Attention now turns to France's budget negotiations following the draft presented on 1 October. With lawmakers entering a 70-day period of debate and amendments, prolonged political uncertainty could keep the euro under pressure well into the final quarter of the year.
Looking ahead
Federal Reserve: Further comments from policymakers will be closely watched for confirmation of another potential rate increase before year-end.
US Treasury yields: The 10-year yield holding above 5.3% remains a key source of dollar support, particularly if risk sentiment deteriorates further.
GBP/EUR: The 1.18 level remains an important near-term reference point following sterling's exceptional nine-day rally.
EUR/USD: The 1.1161 low is the next significant downside level to monitor as selling pressure persists.
French fiscal developments: Budget negotiations and widening sovereign bond spreads remain central risks for the euro.
Oil and geopolitics: Further escalation involving Iran could push energy prices higher, intensifying inflation concerns and encouraging additional defensive positioning across FX markets.