FX markets balance rates, risk and geopolitics
Market overview
Currency markets begin the session with a more cautious tone as investors weigh sticky inflation, shifting rate expectations, geopolitical risk and renewed concerns around fiscal credibility. The dollar has steadied after recent volatility, while higher bond yields and firmer energy prices are creating a less supportive backdrop for the euro. Sterling remains relatively resilient, helped by attractive UK yields, although softer risk appetite is limiting upside. With Jackson Hole beginning today, markets are likely to remain highly sensitive to central bank messaging, particularly any indication that policymakers are becoming less comfortable with the inflation outlook.
USD: Jackson Hole puts policy credibility back in focus
The dollar has found firmer footing after the latest US inflation figures offered little justification for a decisive shift in Federal Reserve expectations. Core PCE inflation was broadly in line with forecasts, while the headline reading came in slightly stronger, reinforcing the view that inflation is easing only gradually.
The wider US picture remains finely balanced. Growth is holding up and business investment remains relatively firm, but household finances are less convincing, with real income growth still subdued. This leaves the door open to further tightening later in the year without making the case overwhelming.
Increasingly, however, the dollar story extends beyond interest rates. Higher long-term Treasury yields, concerns over fiscal sustainability and greater political involvement in economic policy are adding a risk premium that has prevented the currency from fully benefiting from higher yields.
Attention now turns to Jackson Hole and Fed Chair Warsh's keynote speech on Friday. A lack of clarity around the Fed's reaction function or policy outlook could renew concerns over credibility and leave the dollar vulnerable to further selling.
GBP: Carry support keeps sterling resilient
Sterling remains relatively well supported despite a more defensive mood across global markets. GBP/USD has slipped below 1.36 as the dollar strengthens, but the pullback has so far been contained and the broader trend remains constructive.
Risk sentiment continues to present a headwind. Geopolitical uncertainty, higher energy prices and a muted market response to Nvidia's latest earnings have encouraged a more cautious approach from investors. Sterling, as a higher-beta currency, can struggle when risk appetite weakens, yet the pound has held up comparatively well.
One important source of support remains carry. UK yields continue to sit above many developed-market peers, offering investors an attractive return relative to lower-yielding currencies such as the yen, Swiss franc and euro. That yield advantage has helped limit the scale of any correction.
Against the euro, sterling has eased as stronger eurozone data lends support to the single currency. Even so, the recent move still looks more like consolidation than a meaningful reversal. Unless market volatility rises sharply or concerns around the UK's fiscal outlook intensify, sterling weakness may remain relatively contained.
EUR: Energy and geopolitics cloud the outlook
The euro came under pressure yesterday, with EUR/USD falling to a one-month low as stronger US inflation data pushed short-dated Treasury yields higher and kept the prospect of further Fed tightening alive.
Pressure increased later in the session following reports of a potential escalation in the Russia-Ukraine conflict. Gas and broader energy prices moved higher, weighing on the eurozone's terms of trade and reinforcing the region's sensitivity to renewed energy shocks.
This creates a more complicated backdrop for the euro. Recent economic data have been encouraging and have strengthened the case for a more hawkish ECB stance, but geopolitical uncertainty and higher energy costs could quickly revive concerns around growth.
For now, it is too early to treat the latest geopolitical developments as a sustained bearish catalyst for the euro. Attention will also turn to preliminary August inflation figures from Spain and France, which are expected to show firmer headline readings and could add further support to expectations for an ECB rate increase next month.
Looking ahead
Jackson Hole begins today, with markets watching closely for any shift in the global policy debate.
Fed Chair Warsh speaks on Friday, with investors looking for greater clarity on inflation, rates and the Fed's reaction function.
Eurozone inflation data from Spain and France will be watched for confirmation that price pressures remain firm.
Russia-Ukraine developments remain an important risk for the euro, particularly through their impact on energy prices.
Sterling remains supported by carry, although weaker global risk appetite could cap further gains.
Bond yields remain central to FX direction, with markets assessing whether higher yields continue to support currencies or instead increase concerns around fiscal and policy credibility.