Euphoria around interest rate cuts eases
The narrative around interest rate cuts has shifted dramatically from last Friday to Monday, wiping out the “everything rally” that capped last week. After a period of market calm, the focus is squarely back on inflation, and the currency market is a prime example of the change in sentiment.
On Friday, Fed Chair Jerome Powell’s remarks at the Jackson Hole symposium seemed to signal a dovish turn, with his comments on “downside risks to jobs” bolstering hopes for a September rate cut. The market’s reaction was swift and enthusiastic: the U.S. dollar weakened, and risk-on assets surged. This gave the Euro a significant boost, allowing it to erase earlier losses and close the week on a strong note.
Fast forward to yesterday, and the mood is completely different. The market’s initial euphoria has given way to a more sober reality check. Traders are now realizing that while one rate cut may be on the table, the path forward is far from certain. The upcoming inflation reading is a huge wildcard, and the fact that Fed officials are still divided on the future pace of cuts is causing a lot of uncertainty.
This shift has had a clear ripple effect across FX. The U.S. dollar has staged a strong rebound, recovering much of its Friday losses. Consequently, the Euro has given back most of its Friday gains, trading lower against the strengthening greenback. The Canadian dollar, too, is feeling the pressure, bouncing back to levels closer to 1.39 against the USD. Meanwhile, the Japanese Yen, a traditional safe-haven currency, is one of the worst performers as investors abandon defensive positions in favor of the rebounding dollar.
Adding to the market’s volatility, the dollar briefly sold off after news broke that President Trump was dismissing Fed board member Lisa Cook. The President cited an ongoing Department of Justice investigation into her for alleged mortgage application irregularities as his reason. However, Cook is challenging his authority to remove her, and with the case likely heading to court, it’s unclear if the Fed will be short a member until the legal battle is resolved.
The next major test for the market comes in the form of this week’s PCE data, which is widely expected to be higher. This will only add to the “noise” and underscore the Fed’s ongoing dilemma. With inflation now squarely back in the spotlight and the risks of a weaker-than-expected labor market looming, the central bank’s “data-dependent” stance means the market is on a hair trigger. A surprise on either side of the data could easily flip the script. It’s a powerful reminder that while everyone is hoping for rate cuts, the economic conditions that would necessitate them might not be the bullish signal they think it is.
Sentiment takes a hit: The euro’s triple threat
Prime Minister François Bayrou has called a confidence vote for September 8 over his controversial €44 billion austerity plan. His minority government faces the risk of collapse, with major opposition parties pledging to vote against him. This political uncertainty has rattled markets: French bond yields have surged to their highest levels since March, and the spread between French and German 10-year bonds has widened sharply. Meanwhile, EUR/USD has dropped 0.7% so far this week.
This adds pressure to the common currency, which – on the sentiment front – was only just recovering from trade-related debacles, despite recent efforts to finalize something more tangible and, more importantly, eurozone-friendly. And finally, fading optimism over a potential ceasefire or peace deal in Ukraine: a trifecta that ultimately undermines sentiment toward the euro.
Yet dollar sentiment isn’t in great shape either. While tariffs developments have taken a back seat, investors are increasingly focused on the macroeconomic fallout from Trump’s trade agenda and growing threats to the Federal Reserve. Powell’s more dovish-than-expected tone at Jackson Hole last week may have appeased Trump and temporarily contained his persistent criticisms. However, fresh threats to fire Fed Governor Lisa Cook – “effective immediately” – on grounds of allegedly false statements regarding mortgage agreements has left investors wondering what remains of the Fed’s institutional integrity. This marks the second dismissal in less than a month.
EUR/USD may continue to see modest upside from the repricing of Fed rate expectations. Markets are currently pricing in roughly 21 basis points for September, with limited deviation from a full rate cut. That bullish force, however, remains constrained. What could support the euro further is a market interpretation of the Fed’s dovish tilt as a sign of weakened independence under Trump’s influence. Still, a deteriorating job market undermines that narrative, making the dovish stance appear more justified than politically driven. Instead, attacks on the Fed’s renovation site and the dismissal of Fed staff – especially those tied to data releases – remain central to the Fed independence story. This theme could continue to lend support to the euro.
The eurozone data calendar is relatively quiet this week, with the main highlight being the U.S. PCE report due Friday. If the data edges lower as expected, it could encourage EUR/USD to test the 1.17 level. However, a decisive break higher remains constrained by weak euro sentiment, stemming, predominantly, from the French government’s near collapse.
Sterling faces structural strains
Amid broad-based dollar strength on Monday, GBP/USD dipped back below $1.35, remaining confined within a sideways range between its 21-day and 50-day moving averages. GBP/EUR fell to a fresh two-week low of €1.1523, though a rebound may be on the cards if political uncertainty in France begins to exert greater pressure on the euro.
On the domestic front, UK real interest rates have collapsed over the past year – from a peak of 3.3% in September 2024 to just 0.2% today – driven by a surprise uptick in inflation and successive cuts to the Bank of England’s (BoE) policy rate. This erosion in real yields undermines the relative appeal of UK assets, like the pound, especially against economies like the US, where inflation-adjusted returns remain firmly positive. We see this as a long-term headwind capping sterling gains.
BoE Governor Andrew Bailey, speaking at the Jackson Hole Symposium, highlighted the “acute challenges” facing the UK economy. He cited weak underlying growth and a shrinking labour force – pressures exacerbated by post-pandemic participation declines and long-term demographic trends.
The FX options market is already starting to price these risks in as traders keep adding to their bearish expectations on the British currency for eight days in a row, despite an almost 2% advance in GBP/USD so far in August.
It’s a quiet week on the UK data docket, but month-end flows could trigger erratic price action – especially in August, when liquidity tends to be thinner. Hence, investors will remain alert to outsized moves driven more by positioning than fundamentals.
Erratic Dollar keeps the EUR and GBP bid
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Calendar: 25 – 31 August
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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.
