FX markets turn to geopolitics after Fed-driven dollar rally

Market overview

FX markets begin the week with the dollar holding onto much of last week’s advance, but the next move may be determined less by central banks and more by geopolitics. The Fed’s 25bp rate increase pushed US yields higher and lifted the dollar index towards one-month highs, while elevated energy prices and softer risk appetite weighed particularly heavily on higher-beta currencies such as sterling.

Attention now shifts to US-China talks, the Trump-Xi summit and diplomatic activity surrounding the UN General Assembly. Any signs of progress towards easing tensions in the Middle East could pull oil prices lower, improve risk sentiment and reduce pressure for further hawkish repricing across global rates markets. That combination would potentially take some momentum out of the dollar while offering relief to currencies that have struggled under the recent rise in yields and energy costs.

USD: Rally meets resistance

The dollar index gained roughly 1% last week after the Federal Reserve raised rates by 25bp and left the door open to another increase before the end of the year. DXY briefly reached a one-month high before settling around the low-100s.

The focus now shifts towards diplomacy. US and Chinese officials are meeting in New York ahead of Thursday’s summit between Presidents Trump and Xi, with the future of the current trade truce expected to feature prominently alongside tensions in the Middle East and growing competition over artificial intelligence.

Washington may have an incentive to support de-escalation, particularly with the US-China trade arrangement due to expire in November and China maintaining significant economic ties with Iran. Diplomatic activity at the UN General Assembly could reinforce that theme, with Gulf leaders expected to meet Trump and the US President indicating that he would be open to talks with Iranian President Masoud Pezeshkian.

A reduction in geopolitical risk would likely support broader risk appetite, weigh on energy prices and temper expectations for further Fed tightening. That could make it difficult for the dollar to extend last week’s gains, with the 100.50 area on DXY likely to remain an important resistance zone.

GBP: Sterling remains exposed to global risk

Sterling enters the week under pressure from both domestic and international forces. Last week’s Bank of England meeting again highlighted the difficult balance between a cooling labour market and persistent inflation pressures linked to higher energy costs.

Markets continue to price a relatively aggressive tightening path, meaning the greater risk for sterling may come from expectations being revised lower rather than from further hawkish repricing. That leaves the pound particularly sensitive to global bond yields, oil prices and shifts in risk appetite.

GBP/USD has also weakened technically after falling below several important daily moving averages around the low-1.34s. The next major area of interest sits near the 100-week moving average around 1.32. Momentum indicators suggest the recent decline has become stretched, which could encourage a short-term recovery, although the broader trend remains fragile.

GBP/EUR has meanwhile slipped back towards the mid-1.16s, with the 100-day moving average flattening after trending higher through much of the spring and summer. That level is increasingly acting as an anchor for the cross.

EUR: Political risk returns to focus

The euro showed little immediate response to another difficult regional election result for Germany’s CDU, but political risk is becoming harder for investors to ignore.

The party recorded its weakest-ever result in Mecklenburg-Western Pomerania, taking 4.9% of the vote and losing representation in the state parliament as Alternative for Germany emerged as the largest party. The result follows another significant CDU setback in Saxony-Anhalt and has increased scrutiny of Chancellor Friedrich Merz’s leadership.

For now, the market reaction has been limited, partly because there is no obvious alternative governing configuration at federal level. Longer term, however, domestic politics could become a more important theme for the euro, particularly with political uncertainty also building in France ahead of the 2027 presidential election.

This week’s economic calendar is relatively quiet. Preliminary September PMIs and Germany’s Ifo survey will provide the clearest read on whether eurozone activity has remained resilient despite the energy-price shock seen over the summer.

Looking ahead

• US-China talks: Markets will watch for progress ahead of Thursday’s Trump-Xi summit and any indication that the current trade truce could be extended.

• Middle East diplomacy: Developments around the UN General Assembly could influence oil prices, global risk sentiment and rate expectations.

• USD: DXY resistance around 100.50 remains an important technical level following last week’s rally.

• GBP: UK flash PMIs are the main domestic release, although global yields, energy prices and risk sentiment may remain the bigger drivers.

• EUR: Preliminary PMIs and Germany’s Ifo survey will test the resilience of eurozone activity, while political developments in Germany remain in focus.