Dollar tightens its grip on FX markets
Market overview
The dollar remains firmly in the driving seat across FX, with rising global yields, sticky inflation concerns and resilient economic activity keeping pressure on the major currencies. EUR/USD has slipped to a 13-month low, sterling is trying to recover from a three-month trough, and investors remain cautious about fading the latest USD move while US rates continue to reprice higher. The key question for markets is now whether incoming data can justify another leg of dollar strength, or finally give stretched currency pairs room to recover.
That puts today’s US inflation and labour-market releases firmly in focus. Softer consumer confidence and weaker job openings have cooled expectations for an October Fed hike, but the broader rates backdrop remains supportive for the dollar, particularly with long-dated Treasury yields pushing higher. At the same time, European inflation data could influence expectations for the ECB, while stronger UK growth has offered sterling some domestic support. With several major central-bank narratives moving at once, today has the ingredients for another active session across FX.
USD: Yields keep the dollar in control
The dollar remains well supported despite some moderation in expectations for an October Federal Reserve hike. Weaker consumer confidence and a softer JOLTS report pushed near-term tightening expectations lower, but the move was offset by continued pressure across the Treasury market.
Ten-year yields have broken higher, bringing the 5.32% peak from 2007 back into focus. The key signal is that yields continue to rise even as parts of the consumer economy soften, suggesting markets remain more concerned about inflation, Treasury supply and continued strength in investment spending.
US data continue to point to an increasingly divided economy. Manufacturing surveys have shown stronger activity and renewed price pressure, while AI-related capital expenditure continues to support business investment. By contrast, consumer confidence remains subdued and job openings have weakened, with the quits rate holding at 1.9%, suggesting limited acceleration in wage pressure.
For FX, the balance remains constructive for the dollar. Markets continue to leave room for further Fed tightening, supported by firm activity, higher energy prices and a hawkish run of Fed commentary. Unless inflation or employment data disappoint materially, there is limited incentive for policymakers to challenge that pricing.
Attention now turns to September ADP payrolls and August personal spending and PCE inflation. Core PCE is expected to rise from 0.2% to 0.3% month on month. A stronger 0.4% reading, particularly alongside firm labour data, could quickly revive October hike expectations and provide another leg higher for the dollar.
GBP: Sterling steadies as growth surprises
Sterling has recovered some ground after briefly falling to a fresh three-month low against the dollar yesterday.
Prime Minister Burnham’s conference speech generated significant political attention but little immediate response in either gilts or the pound. Proposals around pension reform and the UK’s longer-term relationship with the EU failed to materially shift market pricing, with investors continuing to focus more closely on the approaching Autumn Budget.
There was, however, some support from the domestic growth picture. UK GDP expanded by 0.5% in the second quarter, beating expectations and reinforcing the view that the economy remains more resilient than feared despite high energy costs and wider geopolitical uncertainty.
The decision to fund new spending commitments through changes to the state pension triple lock, rather than additional borrowing, also offered some reassurance around fiscal discipline.
Even so, sterling’s recovery appears to be driven as much by external factors as domestic developments. The easing of near-term Fed hike expectations has taken some momentum out of the dollar overnight, giving GBP/USD room to recover. Global rates, energy prices and the direction of the dollar are likely to remain the dominant drivers in the near term.
EUR: Downside momentum meets growing resistance
EUR/USD fell to a 13-month low yesterday, extending a decline that has accelerated through September as investors have grown more confident in the Federal Reserve’s willingness to keep policy restrictive.
The September Fed rate increase appears to have strengthened confidence in the central bank’s inflation-fighting stance, particularly after earlier uncertainty surrounding Chair Kevin Warsh’s communication and policy framework. Importantly, the dollar has continued to strengthen even though expectations for additional tightening have risen only modestly, suggesting markets are placing greater weight on Fed credibility rather than simply rate differentials.
The scale of the move lower in EUR/USD now looks increasingly stretched. The pair has moved below levels implied by short-term macro fundamentals, potentially reflecting a combination of higher oil prices, softer risk sentiment and a premium for renewed Fed credibility.
Further downside may therefore require another clear shift in US rate expectations. Strong US inflation or employment data could bring an October Fed move back into play and reopen the path lower, with 1.10 becoming a more prominent downside reference if the Fed remains hawkish.
Closer to home, attention turns to September inflation figures from France and Germany following a stronger-than-expected Spanish release. Firm data could encourage a more hawkish tone from ECB speakers and rebuild expectations for further tightening, offering some support to the single currency.
Looking ahead
US ADP payrolls: A stronger labour-market reading would reinforce the case for keeping Fed policy restrictive.
US core PCE: Consensus looks for a rise from 0.2% to 0.3% month on month. A 0.4% print could materially lift October hike expectations.
French and German CPI: Stronger inflation would support the case for additional ECB tightening.
Friday’s US payrolls: The key test for whether the dollar can extend its recent move.
EUR/USD: Further downside likely requires a renewed rise in Fed tightening expectations.
GBP/USD: Sterling remains highly sensitive to broader dollar momentum and global rates.