US Dollar Holds Steady Ahead of CPI Inflation Report

The US dollar remained unchanged following the release of the US Federal Reserve's (Fed) meeting minutes last night. The minutes revealed that nearly all participants believed the risks of rising inflation had lessened, while the risks to employment had grown. After its longest rally in over two years, the dollar is taking a breather as markets await the release of the US CPI inflation report later today.

A closer look at the Fed’s meeting minutes shows that the recent 50 basis point rate cut should not be viewed as a sign of a weakening economic outlook or as an indication that the pace of policy easing would accelerate beyond what participants deemed appropriate. Additionally, almost all members expressed confidence that inflation was on track to reach the 2% target sustainably. While today’s inflation report is expected to show further moderation, bolstering the Fed's projected easing in the months ahead, new inflationary pressures could still emerge. Rising tensions in the Middle East have driven up energy markets, potentially pushing oil prices back above $100 per barrel. Policymakers remain concerned about a repeat of 1970s-style inflation, which would offer strong support to the dollar and US yields.

Sterling Struggles Amid BoE Dovish Stance, Dollar Strengthens Ahead of US Election

The pound is still reeling from Bank of England (BoE) Governor Bailey’s dovish remarks last week. GBP/USD is struggling to regain the $1.31 level, while GBP/EUR remains near the lower end of the €1.19-€1.20 range. However, the BoE is expected to adopt a more gradual approach to monetary policy easing compared to its global counterparts, which may help limit further sterling losses, provided there are no major global risk-off events.

Meanwhile, it’s becoming increasingly evident that the US dollar may stay firm leading up to the US election in November. The dollar’s higher yields and safe haven appeal suggest greater downside risk for GBP/USD compared to GBP/EUR, especially given the European Central Bank’s dovish stance and weak economic data from Europe, which is likely driving the widening UK-German yield spread. A dip below $1.30 against the dollar is possible this month, though GBP/EUR should find support around €1.19. 

Once key risk events like the UK Budget and US election are out of the way, currency traders are expected to shift focus back to monetary policy expectations. Money markets are pricing in a BoE rate cut of about 38 basis points by December, compared to around 50 basis points from both the Federal Reserve and the ECB.

If upcoming economic data remains relatively stable, interest rate differentials could allow the pound to perform better against the dollar and euro. However, a sharp downside surprise in UK services inflation or weak activity data could prompt a more significant dovish shift in BoE rate expectations, further eroding sterling's year-to-date gains.

Euro Weakens Further as US Markets Surge, France Faces Investor Concerns

The euro extended its recent decline, falling to its lowest level since mid-August during yesterday's session. EUR/USD dropped below the $1.10 mark, sliding further to the low $1.09 range. In contrast, the US equity benchmark, the S&P 500, reached another record high and is on track for its best yearly performance ever. This surge in risk appetite has done little to prevent the euro's fall from $1.12 just a week ago.

France is grappling with restoring investor confidence in its sovereign debt as the Prime Minister introduces new measures aimed at reducing the budget deficit to 5%. Additionally, the recent rally in Chinese markets, driven by stimulus measures, has lost momentum, leaving the euro without much support. A downside surprise in today’s US inflation report may be needed to halt the euro’s decline temporarily.

On a positive note, German industrial production grew by 2.9% in August, marking its best monthly performance in nearly three years. However, more robust macroeconomic data will be required to shift sentiment. The Eurozone economic surprise index remains negative and has stayed that way throughout the second half of 2024.