FX markets brace for a pivotal central bank week

Market overview

FX markets remain caught between higher energy prices, tighter rate expectations and a fragile risk backdrop. Monday’s sharp rise in Brent initially pushed bond yields higher and strengthened the dollar, while equities and risk-sensitive currencies came under pressure. However, those moves faded as oil retreated from its highs and concerns around immediate supply disruption eased. The reversal was notable, with the dollar struggling to fully benefit from a combination of higher yields and hawkish central bank pricing. Attention now shifts firmly towards the Federal Reserve and Bank of England, with policy communication likely to matter more than the decisions themselves. The euro remains vulnerable to softer risk sentiment, while sterling continues to show relative resilience outside GBP/USD.

USD: Fed messaging holds the key

The dollar surrendered much of Monday’s advance after DXY touched a one-month high of 99.73. Brent briefly climbed 4.4% to $109.8 and the US 10-year Treasury yield moved above 5%, before both reversed later in the session. DXY subsequently slipped back towards 99.4.

Markets now assign roughly a 90% probability to a 25bp Fed hike on Wednesday and price around two increases across the remaining 2026 meetings. With the immediate decision largely discounted, the greater risk lies in the updated projections and Chair Kevin Warsh’s press conference.

A higher 2026 median rate projection and a firm inflation message could reinforce expectations for further tightening and give the dollar renewed support. Conversely, any reluctance to validate current market pricing could prompt a sharper unwind.

Politically, the Fed also faces growing pressure from the White House for lower rates. That leaves Warsh balancing inflation credibility against an increasingly difficult policy backdrop. From a technical perspective, DXY holding above 99.3 keeps the recent breakout intact, with 99.7 and 100 the next key areas to watch.

GBP: Resilient, but BoE pricing looks stretched

Sterling weakened against the dollar on Monday as higher global yields and softer equities weighed on GBP/USD, which fell to a one-month low. However, the broader picture remains more constructive. Sterling has gained against several G10 currencies, with GBP/CHF reaching a fresh one-year high and GBP/EUR moving back towards 1.17.

UK labour data provided little reason for the Bank of England to turn more hawkish. Wage growth slowed to 3.9%, unemployment remained at 4.9%, payrolls fell for a seventh consecutive month and vacancies declined to a five-year low. The data continue to point towards a low-hire, low-fire labour market with easing wage pressure.

The complication comes from energy. Oil prices above $109 have encouraged markets to price as many as five BoE hikes by the end of 2027. That looks increasingly aggressive given the softer domestic backdrop.

Thursday’s BoE meeting therefore carries asymmetric risk for sterling. Any pushback from Governor Andrew Bailey against current pricing could narrow the pound’s yield advantage. GBP/USD is also approaching important technical support in the low 1.34s, with a sustained break potentially bringing the 1.32 area back into view.

EUR: Risk sentiment keeps pressure on the euro

EUR/USD fell sharply towards 1.1520 on Monday before recovering into the 1.1550 to 1.1570 region. The move suggests the euro is currently responding more strongly to deteriorating global risk sentiment than to the steady build-up in Fed tightening expectations.

Unless geopolitical risks ease materially, a test of 1.15 remains possible this week. The Fed decision itself is unlikely to be the main catalyst given current pricing. Instead, the reaction will depend on whether Warsh reinforces expectations for further tightening.

German ZEW data provide the main European data focus today, with expectations forecast to improve from 34 to 40 and the current situation index from -61 to -52. The impact may prove limited, however, with last week’s hawkish ECB decision still offering some support to the single currency.

EUR/USD is trading close to short-term fair value, but its sensitivity to equities and front-end rates leaves it vulnerable if Wednesday’s Fed meeting delivers a combination of tighter policy expectations and weaker risk appetite. EUR/GBP may also struggle to extend recent declines if the BoE takes a more cautious tone later in the week.

Looking ahead

• Tuesday: German ZEW expectations and current conditions.

• Wednesday: Federal Reserve rate decision, updated projections and Kevin Warsh’s press conference.

• Thursday: Bank of England policy decision and Andrew Bailey’s guidance on the rates outlook.

• Energy: Brent remains a key cross-market driver, particularly for inflation expectations and global bond yields.

• FX levels: DXY 99.3 and 100, EUR/USD 1.15, and the low 1.34s in GBP/USD remain the key near-term areas to watch.