Rates, energy and politics set the tone for FX

Market overview

FX markets open the week with the dollar still holding the upper hand, the euro under pressure and sterling caught between resilient rate support and growing fiscal scrutiny. Higher bond yields, elevated energy prices and shifting central bank expectations are driving the major crosses, while investors continue to favour currencies offering the strongest combination of growth and yield.

The focus now turns to a busy data calendar and whether recent moves can extend. US inflation, ISM surveys and payrolls will test the dollar’s momentum, eurozone CPI will shape expectations for the ECB, and UK political headlines will keep sterling sensitive ahead of the October Budget. With Brent above $100 and bond-market volatility elevated, the backdrop remains supportive of larger moves across FX.

USD: Treasury yields keep the dollar supported

The dollar begins the week firmly supported as resilient US activity and higher rate expectations continue to lift Treasury yields. September’s composite PMI reached its strongest level since 2021, with solid demand and renewed cost pressures helping push the two-year yield towards 4.9%. The dollar has followed the move closely, highlighting the influence of the front end of the US curve.

The rise in the 10-year yield above 5% adds another layer of support, reflecting higher policy expectations, firmer real yields and an increased fiscal premium. The pace of the adjustment is now just as important as the level itself. A steady increase in yields should remain constructive for the dollar, but a sharper rise in rates volatility could begin to weigh on equities and credit, creating a less straightforward reaction across FX.

Energy prices are also keeping inflation concerns alive. Brent above $100 continues to complicate the outlook for global inflation and reinforces the argument for restrictive policy to remain in place for longer.

Attention now turns to PCE inflation, ISM surveys and payrolls. Further evidence of persistent inflation and resilient activity would keep additional Fed tightening in play and could leave DXY targeting 101 to 101.50, particularly if the two-year yield approaches 5%. A weaker labour market print would instead bring the 100 area back into focus.

GBP: Fiscal policy returns to the spotlight

Sterling starts the week with domestic politics and fiscal policy moving higher up the agenda as Labour’s conference continues and the 28 October Budget approaches. Prime Minister Andy Burnham has outlined plans for a future social care system in England based on NHS-style principles, while stressing that the reform would need to be introduced carefully and without placing additional strain on the public finances.

For markets, the immediate issue is how future spending commitments will be funded. Chancellor John Healey has pledged that the 28 October Budget will meet the government’s fiscal rules, but recent borrowing figures have highlighted the pressure on the public finances. UK borrowing reached £18.3 billion in August, above official forecasts.

Sterling and gilts have so far absorbed the fiscal debate relatively calmly, although investors are likely to remain sensitive to any suggestion of large commitments without a clear funding plan. GBP/EUR has also slipped below its 21-day and 100-day moving averages, although the decline has remained gradual rather than disorderly.

Higher energy prices may offer sterling some relative support against the euro if UK yields rise faster than their German equivalents. Wednesday’s final second-quarter GDP estimate provides another domestic catalyst, although fiscal headlines are likely to remain the more important driver.

EUR: Energy and yield differentials weigh on the euro

The euro enters the week close to two-month lows against the dollar after losing more than 1% last week. Recent activity surveys have pointed to a relatively resilient eurozone economy, but that has not been enough to offset the widening rate advantage enjoyed by the US and renewed pressure from energy prices.

The ECB’s relatively hawkish stance remains a source of support, but the scope for further repricing is becoming more limited. Markets are increasingly questioning how much further rates can rise before tighter financial conditions begin to weigh more noticeably on growth.

Energy remains a particular vulnerability. A prolonged period of elevated oil and gas prices would increase concerns around inflation, growth and competitiveness across the eurozone, while also making the ECB’s policy path more difficult to navigate.

European fiscal risk is adding another layer, with wider French-German sovereign spreads attracting greater attention. Friday’s flash eurozone inflation release will therefore be closely watched. A stronger-than-expected core reading could strengthen expectations for another ECB move and provide the euro with some support, while a softer print would leave relative rate differentials firmly in the dollar’s favour.

Looking ahead

• US: PCE inflation, ISM surveys and payrolls will determine whether the rise in Treasury yields and the dollar has further room to run.

• UK: Labour conference speeches will remain in focus for signals on spending, taxation and fiscal discipline ahead of the 28 October Budget.

• Eurozone: Friday’s inflation release will be central to expectations for the ECB’s next move.

• Rates: The US two-year yield approaching 5% remains an important level, alongside the MOVE Index as a gauge of broader bond-market stress.

• Energy: Brent above $100 keeps inflation and growth risks elevated, with European currencies particularly sensitive to a prolonged rise in energy costs.