FX markets brace for a volatile September

Market overview

September opens with the FX market finely balanced between shifting rate expectations, growing policy uncertainty and renewed geopolitical risk. The dollar remains caught between higher US yields and persistent concerns over fiscal credibility, while the euro continues to show surprising resilience and sterling holds firm despite a more fragile domestic backdrop. With inflation, labour-market data and major central bank decisions all approaching, the next few sessions could prove decisive. After a relatively contained August close, the conditions are now in place for a more meaningful break across the major currency pairs.

USD: Higher yields fail to deliver a convincing dollar breakout

The dollar closed August only modestly lower, with DXY ending at 99.428 after trading between 98.800 and 100.014. Kevin Warsh’s hawkish Jackson Hole message helped the currency recover into month-end, but the broader picture remains less supportive than the rise in Treasury yields might suggest.

US policy concerns continue to complicate the traditional relationship between rates and the dollar. Treasury bond buybacks and discussion around greater use of its cash balance have raised questions over whether policymakers could become more active in influencing longer-term borrowing costs. Markets appear increasingly sensitive to the implications for inflation, Federal Reserve independence and the wider US policy premium.

Warsh attempted to counter those concerns by reaffirming the Fed’s commitment to its 2% inflation target. Two-year Treasury yields finished August at 4.344%, while the 10-year closed at 4.752%. Yet the dollar’s muted response suggests investors are demanding more than higher yields alone.

Geopolitical risk adds another variable. Renewed conflict around the Strait of Hormuz has lifted oil prices, freight costs and inflation risks. A prolonged disruption could strengthen the case for tighter US policy and generate safe-haven demand for the dollar, although a larger energy shock would also increase concerns over global growth.

Attention now turns firmly to the US data calendar and the Fed’s 16 September meeting. Strong employment and inflation data could return DXY above 100 and bring 100.50 to 101.00 into focus. A weaker run of releases could instead reopen the 98.80 area.

GBP: Sterling holds firm but domestic risks are building

Sterling ended August slightly stronger against the dollar, despite giving back part of an earlier rally that took GBP/USD above 1.36 to a six-month high.

Much of the move reflected dollar weakness rather than a significant improvement in the UK outlook. Softer US data and growing concern around US fiscal and Treasury policy supported cable, leaving GBP/USD somewhat firmer than relative interest-rate differentials alone would imply.

The picture against the euro was less constructive. GBP/EUR remained largely confined to the 1.16 to 1.17 area after falling back from July’s one-year highs above 1.18, with narrower UK-eurozone yield spreads limiting sterling’s upside.

For now, sterling remains heavily influenced by global risk appetite, the dollar and relative central bank expectations. Domestic factors could become more important as the quarter progresses. UK data has historically shown a tendency to disappoint heading into Q4, while scrutiny of Prime Minister Burnham’s fiscal plans is likely to increase ahead of the Autumn Budget. That combination could test sterling’s recent resilience.

EUR: Resilience keeps buyers interested

EUR/USD has stabilised around 1.1570 following the post-Jackson Hole sell-off and continues to hold a broadly constructive trend from the late-June lows near 1.1320 to 1.1330.

The key development has been the dollar’s inability to translate higher US yields into sustained strength. Concerns surrounding the US fiscal outlook, Treasury policy and rising long-end yields appear to be offsetting some of the support normally associated with a more hawkish Federal Reserve.

The euro’s performance during the latest increase in Middle East tensions has been particularly notable. Despite higher oil prices and rising yields across G10 markets, EUR/USD has remained relatively well supported. That suggests investors are viewing the latest rise in US yields partly through a fiscal-risk lens rather than as a straightforward safe-haven signal for the dollar.

For dollar buyers, rhetoric may no longer be enough. Markets may want to see an actual Fed rate increase before giving greater weight to US yield support.

Today’s eurozone August CPI release is the next domestic focus. Headline inflation is expected to rise to 3.3% from 2.9%, following several stronger national readings. A firm print would reinforce expectations for tighter ECB policy, although much of that prospect is already reflected in market pricing, which could limit any immediate euro reaction.

Looking ahead

• US: ISM, JOLTS, jobless claims and August payrolls will shape expectations ahead of the Fed’s 16 September decision.

• Dollar: DXY above 100 could bring 100.50 to 101.00 into view, while weaker US data leaves 98.80 vulnerable.

• Eurozone: August CPI will be closely watched for further evidence of persistent inflation and its implications for ECB policy.

• Sterling: Attention is likely to shift gradually towards the UK fiscal outlook and the Autumn Budget.

• Geopolitics: Developments around the Strait of Hormuz remain an important driver for oil, inflation expectations, risk sentiment and safe-haven flows.