Summer calm meets inflation risk

Market overview

FX markets are starting the session with plenty of potential catalysts but little conviction. The dollar remains softer after last week’s payrolls disappointment, EUR/USD volatility is close to historic lows, and sterling is holding firm despite renewed scrutiny of UK fiscal policy and long-dated gilt yields. Today’s US CPI release is the immediate focal point and could determine whether recent moves extend or fade. A softer inflation print would reinforce lower US yields and support risk-sensitive currencies, while an upside surprise could quickly revive dollar demand. Beyond the data, energy prices and fiscal policy remain important secondary themes, particularly for the UK, where higher oil prices, inflation concerns and government borrowing expectations risk becoming increasingly intertwined.

USD: CPI holds the key to the next dollar move

The dollar enters today’s inflation release on a weaker footing after payrolls data challenged expectations for a more forceful Federal Reserve. The negative headline print and sizeable downward revisions pushed front-end yields lower, although the fall in unemployment to 4.1% means the labour-market picture is not entirely one-sided.

Attention now turns to core inflation, particularly services. A monthly core CPI reading around 0.2% would support the case for the Fed to remain patient in September and could extend the recent decline in US yields. A firmer result would test that repricing and offer the dollar scope to recover.

DXY remains rangebound near 99.8, below its June high but without a decisive technical breakdown. Softer inflation could bring the May lows back into focus, while a stronger reading would rebuild support ahead of the September Fed meeting.

Fiscal policy is also creeping onto the radar, with reports suggesting President Trump may consider a reduction in Capital Gains Tax ahead of November’s midterm elections. The immediate FX impact could be mildly dollar-negative through stronger risk appetite, although any increase in unfunded tax cuts may place additional pressure on long-dated Treasury yields and complicate the Fed’s policy outlook.

GBP: Sterling steady as gilt risks build

Sterling is recovering against both the euro and dollar, but the backdrop remains vulnerable. GBP/EUR is back around 1.17, with support emerging near 1.1650, while GBP/USD has reclaimed 1.35 as short-term momentum improves.

The bigger risk sits in the gilt market. Thirty-year yields are moving back towards July’s highs and remain close to the multi-decade peaks reached in May. That is important because sterling has previously struggled when long-end yields rise on concerns over inflation, borrowing and fiscal credibility rather than stronger growth.

Higher oil prices could sharpen that problem by adding to UK inflation pressures while weighing on activity and public finances. Reports that Treasury officials are concerned about the government making greater use of flexibility within the fiscal rules have added another potential source of risk. Markets may become increasingly sensitive to any suggestion that higher investment spending will be financed through materially greater borrowing.

For now, the pound is taking the headlines in its stride. However, another rise in oil prices or long-dated gilt yields could encourage investors to rebuild a fiscal risk premium into UK assets.

EUR: Low volatility leaves room for a CPI surprise

EUR/USD remains subdued despite stronger eurozone activity data and a run of economic releases that have generally exceeded expectations. One-year implied volatility has fallen to around 5.8%, close to levels last seen in late 2024, underlining the lack of conviction across the market.

Overnight volatility has risen to around 6.9% ahead of US CPI, but options are still pricing a move of only about 0.4% in either direction. Risk reversals also remain close to neutral, suggesting investors see little need to hedge aggressively against a large move higher or lower.

That calm could make today’s reaction more pronounced if inflation delivers a meaningful surprise. A softer US CPI print would favour another test of last week’s EUR/USD high near 1.1580, while a stronger reading could quickly restore dollar support.

The euro is also being held back by elevated European natural gas prices and continued uncertainty in the Gulf. Reports of mediation efforts involving Pakistan and Oman have offered some encouragement, but the geopolitical outlook remains unclear. With another round of US inflation and labour-market data, as well as Jackson Hole, still to come before the September Fed meeting, the market may be reluctant to chase a major breakout without a clear catalyst.

Looking ahead

• US CPI: Core inflation will be the main driver for rates and the dollar, with a softer print likely to reinforce the post-payrolls move.

• EUR/USD: A break above 1.1580 would strengthen the near-term bullish case, although subdued summer liquidity may limit follow-through.

• GBP: Watch 30-year gilt yields closely. A move back towards recent highs could begin to weigh more heavily on sterling.

• Energy: Further gains in oil and European gas prices would increase inflation concerns and could create greater divergence across G10 FX.

• Fiscal headlines: US tax policy and UK borrowing plans are becoming more relevant for long-end bond markets and could increasingly spill into currencies.

• Beyond today: Jackson Hole and another round of US CPI and employment data remain important before the Fed’s September decision.