USD: Hawks and hostilities
The US dollar continues to draw support from a combination of higher US yields, elevated energy prices and renewed geopolitical tensions. Although the Fed’s hawkish rate hike last month was largely anticipated, markets continue to digest the implications of policymakers signalling that further tightening remains on the table. Fed minutes last night showed officials increasingly view inflation as persistent and financial conditions as insufficiently restrictive, reinforcing the higher-for-longer narrative.
The rates backdrop remains constructive. US 10-year yields are holding above 5.3%, while rising energy costs continue to complicate the inflation outlook. Brent crude is back on the rise after reports that the White House is considering additional military options against Iran, while fresh attacks on commercial shipping have kept supply concerns elevated.
At the same time, the euro faces growing headwinds from widening sovereign spreads across the bloc owing to French fiscal fears. With the euro accounting for more than half of the US dollar index basket, renewed pressure on European bonds and the common currency is providing an additional tailwind for the dollar.
Risk sentiment has also softened. Equities have retreated from record highs as investors grapple with higher discount rates, geopolitical uncertainty and the prospect of further policy tightening. The resulting move into defensive assets has reinforced demand for the dollar.
EUR: Little joy for the euro near term
The euro finds itself between a rock and a hard place. Concerns over France’s fiscal outlook continue to dominate, while the domestic political backdrop limits confidence that the eurozone’s second-largest economy can efficiently navigate its budgetary impasse. This combination helps explain the intense bearish pressure on the single currency in recent weeks.
EUR/USD came within touching distance of the 5 October low at 1.1161 yesterday, falling over 0.5% on the day. The pair continues to trade at levels not seen since May 2025.
EUR/GBP also extended its decline, dropping to a 16-month low of 0.8448, its weakest level since June 2025.
It is difficult to envisage any sustained euro rebound in the short term. The ECB’s hawkish stance has lost much of its potency in supporting the currency, if it ever had much to begin with. Even at the height of geopolitical tensions between the US and Iran, a tightening bias from the ECB failed to generate meaningful support for the euro, as growth concerns ultimately outweighed rate differentials.
Now, France’s bond market turmoil, and the risk of broader contagion across eurozone sovereign debt markets, have themselves started to erode expectations of further ECB tightening. Markets have all but priced out the chances of a hike this month, despite still elevated energy prices.
Higher rates would only worsen France’s fiscal challenges. Yet a dovish pivot offers little comfort for the euro either. Beyond eroding the currency’s yield appeal, the central bank risks appearing less independent and more reactive to fiscal stress, an outcome that is unlikely to inspire confidence in the euro.
Developments surrounding France’s recently announced budget (1 October) will be a key focus in the coming weeks and months. Following the presentation of the draft, lawmakers now have 70 days to debate and amend the proposal before a final vote, leaving the euro vulnerable to further downside pressure.
GBP: A rare winning streak
GBP/EUR recorded nine consecutive daily gains, a rare occurrence since the euro’s inception. It is therefore little surprise to see some profit-taking emerge this morning, nudging the pair back below 1.18.
The broader euro story remains challenging. Fiscal concerns in France continue to dominate, with the spread between French and German 10-year yields widening to levels not seen since 2011. At the same time, investors have been scaling back ECB tightening expectations as political uncertainty and bond market stress weigh on sentiment. That combination has done much of the heavy lifting for GBP/EUR’s recent rally.
Against the dollar, the picture remains less favourable. GBP/USD is hovering around the low-1.32s, with the recent rebound from three-month lows proving modest. The dollar continues to benefit from a combination of elevated Treasury yields, safe-haven demand and expectations that the Fed will raise rates again before year-end, following last night’s FOMC minutes.
For sterling, the support story remains one of relative yields and carry. UK bond yields remain among the highest in the developed world, attracting capital despite concerns around the fiscal outlook. In a low-volatility environment, those carry dynamics continue to favour the pound.
Technically, GBP/EUR’s move above 1.18 is significant, but a sustained advance requires a fresh deterioration in the euro story. Meanwhile, sterling’s inability to recover meaningfully against the dollar highlights a recurring theme: investors remain willing to buy GBP on a relative basis against Europe, but are far less enthusiastic when the alternative is a dollar offering both yield and safety.
For now, sterling’s strength remains selective. The pound is benefitting from looking like the least troublesome option within Europe, rather than from a wholesale re-rating of the UK outlook.
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Calendar: October 05-09
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*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.
