USD: Retreats from 18-month highs
The US dollar surrendered its post-inflation gains overnight, with a sharp rally in Treasuries dragging yields lower and knocking the greenback off 18-month highs. The reversal came despite a week of surprisingly strong inflation data. US producer prices rose 1.3% in September, the largest increase in over four years, reinforcing the message from a firmer-than-expected CPI report that price pressures remain uncomfortably sticky.
The trigger was renewed anxiety surrounding the AI trade. The Philadelphia Semiconductor Index has now fallen back into bear market territory, while concerns over the sustainability of massive AI-related capital expenditure and the impact of higher borrowing costs weighed heavily on technology stocks. The fallout has not been confined to the US. South Korea’s Kospi briefly entered a bear market this week as investors questioned whether elevated financing costs and slowing returns could undermine the global AI investment cycle.
Ordinarily, a bout of risk aversion would favour the dollar. However, the greenback is increasingly intertwined with the AI narrative itself. US exceptionalism, capital inflows and dollar strength have all been underpinned by America’s perceived leadership in AI. As a result, weakness in the sector is no longer an unambiguous positive for the currency.
That said, it may be premature to conclude that bond yields have peaked. Treasury markets appear increasingly at odds with the macro backdrop of accelerating inflation, resilient growth and rising energy prices. Fed Chair Warsh reinforced expectations for no move this month, but his enthusiasm for AI’s economic potential and remarks supporting synchronised global monetary tightening suggest markets may be too quick to price out further policy restraint. For now, the bond rally looks more like a positioning adjustment than a decisive shift in the inflation story.
EUR: Euro bear case unchanged despite bond rally
It was telling that, despite yesterday’s hotter-than-expected US PPI print, bonds in the US and elsewhere continued to rally.
AI-related concerns resurfaced this week, triggering renewed demand for bonds as investors rotated out of risk assets and into safer alternatives.
We find it somewhat ironic that investors have spent months shunning bonds amid rising inflation expectations and resilient growth prospects. Now, however, they appear to be shifting towards a weaker growth narrative, fuelling renewed demand for fixed income.
In our view, it is more likely that returns look way too attractive to miss out on given how yields currently sit, and the AI-driven selloff provided the trigger. We therefore doubt that this bond rally will be sustained beyond this week.
That should leave the near-term bearish case for the euro broadly intact. France has begun negotiations to secure approval of its budget, leaving the euro vulnerable given the lack of a parliamentary majority to ensure a smooth process.
Aside from today’s final release of eurozone September inflation data, the calendar is relatively light. We would expect some consolidation around the 1.12 level in the coming days.
GBP: Pound jumps to 1.33 on dollar weakness
Sterling has found some breathing room at the end of the week, with GBP/USD rebounding towards 1.33 as the dollar’s powerful rally shows signs of fatigue. After surging to fresh multi-month highs, the greenback has succumbed to a degree of profit-taking, allowing cable to recover from recent lows. However, this still looks more like a correction within a broader dollar uptrend than the beginning of a sustained sterling rally.
The pound’s own fundamentals remain mixed. On one hand, expectations that the Bank of England may need to keep policy restrictive for longer, particularly against a backdrop of elevated energy prices and sticky inflation pressures, continue to provide support. On the other, sterling remains vulnerable to swings in global risk sentiment and has struggled to outperform most major peers outside of the euro.
Indeed, the more compelling sterling story remains against the single currency. GBP/EUR continues to trade near its highest levels of the year, supported less by outright confidence in the UK and more by persistent concerns surrounding the eurozone’s fiscal outlook. Widening sovereign spreads and lingering doubts over France’s public finances continue to act as a headwind for the euro.
Technically, GBP/USD’s rebound back towards 1.33 eases immediate downside pressure, but the pair remains below key levels lost during the recent sell-off. Meanwhile, GBP/EUR’s successful break above 1.18 continues to bring the psychologically important 1.20 level into view. For now, sterling is benefitting from a softer dollar and a weaker euro, but its fortunes remain heavily tied to the broader global macro backdrop and investor appetite for risk.
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Calendar: October 12-16
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