Dollar on the move
With no clear bearish drivers for the US dollar, its recent recovery from over a one-year low last month appears set to continue in the near term. The first phase of the dollar’s resurgence was driven by the strength of the US economy, but the second phase may be shaped by political factors. Both dynamics are pushing bond yields higher, not only in the US but across most major economies.
The resilience of the US economy goes beyond the impressive jobs report for September and the drop in the unemployment rate. Retail sales and the ISM services index also exceeded expectations. In addition, core inflation has gained momentum, signalling that inflation remains a persistent issue. Consequently, expectations for a quick reversal in Federal Reserve policy have been scaled back, fuelling a yield-driven rally in the dollar. Aside from the US’s economic strength, geopolitical and domestic political developments are providing further support for the dollar. Gold hit a record high on Monday, as tensions in the Middle East and a tightening US election race prompted a flight to safe-haven assets, including the US dollar.
The outcome of the US election is also crucial. Improved polling for Donald Trump could reinforce the upward momentum in bond yields and the dollar, given the potential implications for trade, fiscal, and monetary policies. With the election essentially a toss-up, it’s challenging for traders to predict the outcome, which may explain why EUR/USD and GBP/USD are struggling at the $1.08 and $1.30 levels, respectively. However, a Trump victory could knock as much as 5% off these exchange rates by the end of the year.
Pound hit by rising global yields
UK bond yields surged this morning across the yield curve, mirroring movements in major economies across the US, Europe, and Asia. Traders are trying to anticipate the future path of global interest rates, and with central banks in the G3 economies pricing in less easing over the next 24 months, the pound and other pro-cyclical currencies have faced renewed selling pressure against the US dollar. This trend has been evident since the interest rate hiking cycle ended in 2022.
The situation is largely driven by developments in the US. The resilience of the US economy has surprised market participants and central bank policymakers alike, prompting traders to scale back aggressive rate cut expectations. However, in the UK, signs of moderating inflation, a loosening labour market, and weakening economic momentum should, in theory, have increased the likelihood of rate cuts. A 25-basis-point cut is fully priced in for November, with a 70% chance of another in December, but the recent surge in bond yields suggests some uncertainty among bond traders about back-to-back cuts. Additionally, with the Bank of England no longer seen as an outlier in hawkishness, and overall G3 easing expectations being lowered, the pound has struggled against the dollar.
GBP/USD is hovering around $1.30 today, down nearly 3% for the month, though it remains almost 3% higher year-to-date. It still sits two cents above its five-year average of $1.28, which also aligns with its 200-day moving average – a level it often gravitates towards, as seen in August. Meanwhile, GBP/EUR remains above €1.20, close to a two-year high, buoyed by favourable growth and yield differentials for the pound.
Break of $1.08 in sight
The rise in US Treasury yields across the curve has dominated market discussions at the start of the week. The euro, like many other pro-risk currencies, has been unable to resist the downward pressure caused by widening rate differentials and is once again nearing the $1.08 mark. EUR/USD seems to be largely driven by developments in the US, where enthusiasm for Trump-related trade policies has resurged.
The negative economic news from Europe has done little to support the euro. Recent remarks from top European Central Bank members, such as François Villeroy de Galhau, suggesting that inflation will fall below 2% early next year, have paved the way for further policy easing. The ECB is expected to cut rates in December, followed by quarterly reductions throughout next year, which could see the deposit rate fall to between 1.75% and 2.0% by the end of 2025.
German producer inflation for September also came in lower than expected, with the PPI falling by 1.4%, compared to the anticipated decline of 0.8%. Christine Lagarde is scheduled to speak three times over the next two days, though it is unlikely her comments will shift market expectations regarding the ECB’s next policy move.
