USD: Hawkish Fed leaves the dollar playing catch-up
The Federal Reserve (Fed) delivered a unanimous 25bp hike and a hawkish dot plot on Wednesday, with 16 of 18 officials projecting at least one more move this year and a median fed funds rate of 4.125% for end-2026. The initial dollar reaction was positive but contained: the US dollar index (DXY) rose around 0.5% to a seven-week high. With two-year yields subsequently easing from Wednesday’s peak of 4.74% to 4.69% on Thursday, the dollar ended up tracking rates lower and ended essentially flat on the day. That is not unusual. The more relevant observation is that even at Wednesday’s peak, the dollar’s gain was modest relative to the front-end repricing. Some catch-up between short-end rates and spot FX may remain, but even as US policy premium declines, it continues to limit the dollar’s upside.
Higher front-end yields are still providing a floor under the currency, though not enough momentum to force a breakout. A higher expected Fed path should widen the dollar’s carry advantage and attract capital into US assets. To some extent, that transmission is working. But markets appear increasingly inclined to read the Fed’s tightening as a response to persistent inflation rather than evidence of underlying economic outperformance, reducing the dollar’s sensitivity to higher yields. The fiscal backdrop adds another constraint. Gold’s advance as the dollar surrendered its post-Fed gains is consistent with continued demand for protection against fiscal and inflation risks, although one session cannot confirm that the broader debasement trade is back.
Elsewhere, the Bank of Japan (BoJ) failed to provide the hawkish catalyst the yen needed. Despite delivering the expected and fully priced-in rate hike, the decision was marred by two policymakers voting against the move, none pushing for a larger increase, and little urgency in the statement around the need for further tightening. The underwhelming outcome has reinforced the yen’s yield disadvantage, with USD/JPY up more than 2% this week as the yen hits a fresh two-week low and tumbles against all major peers. With the dollar still not fully reflecting the recent rise in US short-end yields, the lack of a hawkish BoJ counterweight leaves scope for the post-Fed dollar advance to extend.
EUR: Energy relief slows slide
EUR/USD remains below 1.15 heading into the end of the week, after the Fed’s hawkish message drove a sharp widening in short-term rate differentials and pushed the pair firmly lower. While the ECB’s own hawkish stance provides some support, it has struggled to compete with the renewed yield advantage of the dollar.
Encouragingly for the euro, the decline in oil prices through the latter half of the week has taken some heat out of the sell-off. Energy remains a key transmission channel for EUR/USD, given the eurozone’s greater exposure to imported energy.
Still, this looks more like a brake on euro weakness in the short term than a catalyst for recovery. The Fed has reset the relative rates backdrop firmly in the dollar’s favour, while EUR/USD’s short-term fair-value dynamics have deteriorated alongside higher US yields and weaker risk sentiment.
Price action elsewhere has been more favourable. EUR/GBP and EUR/JPY have both moved higher, although largely due to sterling and yen weakness following their respective central-bank meetings rather than renewed demand for the euro itself.
For EUR/USD, the message into the weekend is therefore relatively simple: falling oil has slowed the descent, but has not yet changed the direction of travel. Absent a deeper energy correction or softer US rates backdrop, a test of the 1.14 level remains the key downside risk.
GBP: BoE holds steady, leaving door open to hikes
The Bank of England (BoE) left rates unchanged at 3.75% at yesterday’s policy meeting. The vote split was 6-3, with three members backing a hike.
There were few surprises. MPC members are clearly becoming more concerned about persistently high energy prices, and the minutes suggest that unless energy prices retreat meaningfully, a rate hike is becoming increasingly likely.
That said, policymakers also highlighted the case for patience. There remains broad agreement that inflation risks are still largely an energy story, with limited evidence of spillover into the wider CPI basket. Members also noted that restrictive financial conditions are doing some of the heavy lifting, while a soft labour market is helping contain second-round effects.
With markets having built up a strongly hawkish bias in recent weeks amid the surge in energy prices, there was little in the decision to exceed expectations. Sterling consequently sold off against most major peers with GBP/USD falling further south of the 1.34 handle.
From here, oil prices and incoming data will determine whether the Bank’s next move is a hike. Following yesterday’s meeting, markets pared back some hawkish bets, though a November hike remains the base case, with around an 80% probability priced in. By April 2027, markets are still pricing in just under three 25bp hikes.
With a quiet data calendar, GBP/EUR is likely to remain range-bound in the coming days. However, the approaching Autumn Budget leaves the pair vulnerable to fiscal policy headlines.
Market snapshot
Table: Currency trends, trading ranges & technical indicators
Key global risk events
Calendar: September 14-18
All times are in BST
Have a question? [email protected]
*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
