US Dollar Rises Slightly After Upward GDP Revision, But Faces Worst Month of 2024

The US dollar edged higher on Thursday following revised data showing that the US economy grew at a marginally stronger pace in the second quarter than initially reported. Despite this uptick, the dollar has declined each week this month and is on track to record its worst performance of 2024.

The revised estimate for the second quarter's real GDP increased to 3.0%, up by 0.2 percentage points from the previous estimate, driven by stronger consumer spending. However, downward revisions to investment and other key categories tempered the overall outlook. Confidence remains high that the Federal Reserve (Fed) will soon begin easing monetary policy, encouraging traders to seek higher yields in currencies like the New Zealand dollar and Swedish krona. While the US dollar is attempting to recover some recent losses, a significant rebound appears unlikely if market expectations about the Fed hold true.

Next week’s August jobs report could reveal further labour market weaknesses, potentially prompting the Fed to initiate its easing cycle with a more aggressive 50-basis-point rate cut in September. Meanwhile, the Fed’s preferred inflation measure, the PCE price index, is due today and could influence the dollar’s performance, especially if it exceeds expectations, providing some support as the month closes.

Pound Set for Largest Monthly Gain Since November Despite Pullback from 2-Year Highs

Despite the pound retreating from its 2-year highs against the US dollar, it remains on track to achieve its largest monthly gain since November, standing over 6% above its 2-year average rate of approximately $1.24. The Bank of England’s (BoE) broad sterling index is also approaching the July peak, which represents its highest level since the Brexit vote in June 2016.

In other currency pairs, GBP/EUR is nearing the €1.19 level—a mark it has surpassed for only 16 days in the past two years. The pound's strength has been fueled by stronger-than-expected UK economic data, contrasting with growing concerns in both the Eurozone and the US. This has led the BoE to caution against aggressive policy easing, with markets responding by pricing in just 40 basis points of cuts for this year. Consequently, FX options traders are more bullish on the pound's short-term prospects than they have been since 2020, as investors continue to reassess the relative interest-rate trajectories of the Fed and BoE.

However, with much of the Fed-driven dollar weakness already factored in, there’s no clear catalyst for the pound to push towards the $1.35 mark. Attention is now shifting to the upcoming decisions by the Fed and BoE, and particularly to UK Chancellor Reeves’ first budget at the end of October, which could play a pivotal role in determining whether sterling's bullish momentum can be sustained through the rest of 2024.

Euro Continues Decline Amid Softer European Inflation Data and Strong US Economic Performance

The euro extended its weekly decline to over 1%, dropping an additional 0.4% on Thursday due to weak preliminary inflation data from Europe and signs of robust US economic performance. Meanwhile, European stocks and bonds advanced as investors reacted positively to softer-than-expected German inflation figures, which are anticipated to influence the Eurozone's headline rate and fuel hopes for adjustments by the European Central Bank (ECB).

In August, Germany's preliminary annual inflation rate unexpectedly fell to 1.9%, below the forecasted 2.1% and down from 2.3% in the previous month. This marks the lowest rate since March 2021. On a monthly basis, the CPI edged down by 0.1%, contrary to expectations of a 0.1% increase. The EU-harmonised CPI also dropped to 2% year-on-year, below the anticipated 2.3%.

This downside surprise, along with similarly weak Spanish CPI data, has raised expectations that today's headline Eurozone inflation rate could come in lower than market consensus, increasing the likelihood of ECB easing. The central bank’s future policy path remains uncertain after it abandoned forward guidance in its July meeting. ECB official Patsalides indicated that further rate cuts are likely if the ECB's projections continue to hold. If the Eurozone inflation figure today comes in below expectations, European bonds are expected to advance further, which would be negative for the euro. However, the impact will largely depend on progress in the services and core inflation metrics, which have remained stubbornly high throughout the year.

Market Dynamics Reflect Growing Expectations for Fed Rate Cuts Amid Economic Uncertainty

Investors are increasingly positioning for anticipated rate cuts by the Federal Reserve, following Chair Powell’s dovish remarks at the Jackson Hole conference. Swap prices suggest a consensus of around 100 basis points in rate cuts across the Fed’s three remaining decisions this year, implying at least one significant 50 basis point reduction. However, recent signs of resilience in U.S. economic growth, highlighted by a sharp rebound in durable goods orders, have raised doubts about the extent of the upcoming easing cycle. With the high threshold for further dovish adjustments, a major decline in the USD may require markets to fully anticipate a U.S. recession. In this context, the absence of major U.S. economic data this week could benefit the dollar, though initial jobless claims might draw increased attention as the labor market has become a key indicator for gauging the Fed’s potential easing path.

The prevailing Fed narrative is broadly negative for the dollar, driven by expectations of aggressive policy easing. This sentiment shift is evident in recent positioning data, where speculators have turned bullish on the euro, pound, and yen against the dollar for the first time since early 2021.

Sterling Resilient Amid Global Risk Sentiment Despite Limited UK Economic Data

With no major UK economic data releases, sterling remains vulnerable to global risk sentiment, yet the currency has shown resilience despite a modest increase in risk aversion in financial markets this week. GBP/USD continues to hold firm at $1.32, a level it has only surpassed for four days over the past two years, while GBP/EUR hovers near €1.19, a threshold exceeded for just 16 days in the same period.

In early August, the Bank of England (BoE) reduced its main rate by 25 basis points to 5%. Markets are currently anticipating an additional 40 basis points in cuts by the end of the year. However, stronger-than-expected UK economic data and cautious comments from BoE Governor Andrew Bailey on further rate reductions have moderated these expectations. Consequently, both 2-year and 10-year UK gilt yields have risen above 4%, enhancing the pound's yield advantage against most major currencies. While there is potential for further short-term weakening of sterling, GBP/USD has already corrected from overbought levels due to recent consolidation.

On the fiscal front, UK Prime Minister Keir Starmer has acknowledged the challenges ahead in addressing issues linked to the previous Conservative government, warning that conditions may deteriorate before they improve. The upcoming Autumn budget, along with anticipated tax increases, adds some uncertainty to the UK's growth outlook.

German Inflation Drops to Lowest Level Since 2021 as Eurozone Awaits Further Slowdown

Germany's annual inflation is expected to decrease to 2.1% in August, marking the lowest level since April 2021. Similarly, Eurozone inflation data, set to be released tomorrow, is projected to show a slowdown to 2.2% year-on-year, the lowest in over three years and down from 2.6% in July. Despite these indications of cooling inflation, market expectations for European Central Bank (ECB) rate cuts remain unchanged. Traders are holding steady on their bets, pricing in a 25bps cut next month, 65bps by the end of the year, and 157bps by the close of 2025.

The EUR/USD pair has retreated to a three-session low of around $1.112, extending its losses for the week. The pair has shed approximately 0.7% from its recent high but still remains nearly 3% higher for the month. With markets pricing in the bottom of the dollar smile scenario and no significant U.S. economic data this week, the dollar is likely to maintain its strength. Consequently, EUR/USD may struggle to climb back toward $1.120, with a potential retest of the $1.110 support level on the horizon.

Dollar Faces Mounting Pressure Despite Safe Haven Flows Amid Fed Rate Cut Expectations

Global FX traders are increasingly adopting bearish dollar strategies ahead of the September Federal Reserve (Fed) rate decision. Although recent risk aversion, fuelled by concerns over the AI sector and rising geopolitical tensions, has driven safe haven flows into the US currency, cushioning its decline, the dollar index remains on track for its worst month of 2024. This trend persists despite a modest rebound from 1-year lows, as growing signals suggest the Fed will cut rates in September. Meanwhile, US consumer confidence improved in August, with the index rising to 103.3 from 101.9, beating forecasts of 100.7. However, despite this six-month high, the labour market differential reading fell to its lowest level since March 2021. 

Concerns over the US labour market have overshadowed the narrative, but traders are still betting on a 25 or 50 basis point rate cut in September, with up to four 25 basis point cuts by year-end.

Pound Surges to Two-Year High as Bullish Sentiment Grows Amid Diverging Rate Expectations

The pound has surged beyond $1.32 against the US dollar, reaching its highest level in over two years. Options traders are increasingly bullish on the currency’s prospects for the next month, marking the most optimistic outlook since 2020. This sentiment is driven by a growing belief that the Federal Reserve (Fed) will cut interest rates more aggressively than the Bank of England (BoE).

Although the BoE has already reduced rates this year from 5.25% to 5.00%, market expectations indicate that the Fed will ease more rapidly. Currently, markets are pricing in around five basis points of easing from the BoE next month, compared to about 30 basis points for the Fed. For the rest of the year, the BoE is expected to cut less than 40 basis points, while the Fed is anticipated to reduce rates by 100 basis points. Reflecting this outlook, options traders have become increasingly bullish on the pound, with one-month risk reversals showing the largest spread in favour of sterling since the start of the pandemic.

BoE Governor Andrew Bailey has cautioned that monetary policy will need to remain restrictive for an extended period, indicating that the easing cycle will be gradual. His remarks suggest a sustained divergence between US and UK rates, which is likely to continue supporting sterling.

European Markets Stagnate Amid Thin Trading; Euro Faces Pressure Ahead of Key Inflation Data

Tuesday saw little movement across European markets, with trading volumes remaining thin. Equity markets ended the day largely unchanged, and bond yields showed minimal variation. However, the broader Euro index closed in the red as concerns over weakening domestic fundamentals grew, while the EUR/USD pair edged down to $1.116 as month-end flows influenced the forex market. The euro's recent rally above $1.12 may have peaked, with technical indicators pointing to a potential pullback.

Investors are becoming increasingly cautious ahead of Friday’s release of Eurozone inflation data for August, which could significantly impact the European Central Bank's (ECB) monetary policy. Inflation in Germany and the wider Eurozone is expected to drop to its lowest level in over three years. Despite ECB officials signalling a cautious approach to rate cuts, markets are still pricing in about 65 basis points of cuts by year-end.

Meanwhile, the EUR/CHF pair fell nearly 0.5%, hitting a three-week low due to safe-haven outflows. In France, political tensions resurfaced as President Macron faced difficulties in forming a new government. After four days of discussions with party leaders, Macron ruled out forming a government with the left-wing Nouveau Front Populaire (NFP) alliance, citing the need for “institutional stability.” If a new government isn’t formed, a budget led by caretaker PM Gabriel Attal could result in €10 billion in cuts, which falls short of Brussels’ expectations. This uncertainty widened the OAT-Bund 10-year spread to 73 basis points, up 2 basis points from the previous day, adding further pressure on the euro.

Pound Sterling has maintained its positive momentum due to constructive market sentiment and contrasting speeches from Andrew Bailey and Jerome Powell on Friday. However, we anticipate that further outperformance will be more muted in the near term. Bank of England Governor Andrew Bailey’s remarks that it is “too early to declare victory” over inflation have supported market expectations that the Bank will skip another rate cut in September. In contrast, both the European Central Bank and the Federal Reserve are expected to cut rates in September, with potential further cuts before year-end. This slower path of cuts from the Bank of England provides fundamental support for the Pound against both the Euro and Dollar.

Constructive global market sentiment has been another key driver behind the Pound’s recent outperformance. Friday’s jump in stocks propelled the UK currency to new highs against the Dollar and bolstered its recovery against the Euro. The Pound to Euro exchange rate rose above 1.18, while the Pound to Dollar pairing reached 1.32. Over a one-week period, the Pound has been the best-performing G10 currency and remains 2024’s best performer. However, Monday saw markets give back some recent gains, particularly against the U.S. Dollar, due to losses centred on the U.S. technology sector ahead of Nvidia’s midweek results announcement.

Disappointment in Nvidia’s performance could bolster the Dollar from recent levels, but we do not see this significantly impacting Pound exchange rates. Pullbacks in GBP/USD are likely to be shallow as long as the market expects the Federal Reserve to deliver several interest rate cuts in the coming months. Looking ahead, we expect the Pound’s outperformance to be more muted, with GBP/USD potentially capped at 1.32 in the near term. The exchange rate has become overbought in the short term, and some unwinding is necessary. Monday’s losses in GBP/USD linked to the U.S. tech sector selloff suggest a broader market pullback will temporarily weigh on the UK currency.

Meanwhile, GBP/EUR is now in its fifth daily advance, which is unusual for this exchange rate. GBP/EUR is a slow mover with a mean-reverting tendency, and some softening is possible if global markets face a setback. We will be watching inflation data from the Eurozone this week, with Germany’s data on Thursday and all-Eurozone data on Friday. Any undershoot in these data could potentially boost expectations for ECB rate cuts, which would, in turn, weigh on the Euro.