USD: Reflation narrative remains in control
The US dollar remains well supported as markets continue to focus on the same trio of themes that have dominated recent weeks: resilient growth, elevated inflation risks and higher bond yields. While Houthi attacks on Saudi Arabia and renewed uncertainty surrounding Middle East energy flows have kept geopolitical tensions elevated, FX markets appear more interested in what this means for inflation and Fed policy than the headlines themselves.
The broader backdrop remains one of global reflation. Higher commodity prices, strong AI-related investment and resilient US activity are keeping upward pressure on real yields, while persistent fiscal deficits and heavy debt issuance continue to lift term premia globally. US yields remain near multi-decade highs, reinforcing the dollar’s rate advantage.
Recent US data have done little to challenge that narrative. Manufacturing activity remains expansionary, inflation pressures are proving sticky, and while the labour market is gradually cooling, there is little evidence of a sharp deterioration in growth. By contrast, Europe’s fiscal and energy vulnerabilities continue to leave the region more exposed to the ongoing bond market sell-off, helping to weigh on the euro and indirectly support the dollar.
Attention now turns to Wednesday’s CPI release. Markets continue to price around an 80% chance of one further Fed hike by year-end. An in-line inflation reading is unlikely to materially alter that outlook. For now, the combination of resilient US growth, elevated energy prices and persistently high yields continues to favour the dollar, particularly while risk sentiment remains fragile.
EUR: Fiscal fears will keep the pressure on
The euro is attempting a rebound from oversold conditions this morning but remains below 1.12 versus the US dollar. EUR/USD may just consolidate close to its year-to-date lows before the downtrend resumes as investors continue to focus on the region’s fiscal vulnerabilities. French sovereign spreads remain near their widest levels since 2011, with term premia shooting higher following last week’s competing budget proposals, reinforcing concerns about the sustainability of the country’s public finances and the broader implications for eurozone stability.
Attention now turns to parliamentary discussions around the French government’s €43bn savings package. While there is growing speculation that the budget could ultimately be pushed through via decree, the political backdrop remains highly uncertain. Markets appear to be taking some comfort from the view that opposition parties may avoid triggering a government collapse, but that is a low bar for optimism and does little to improve the euro’s fundamental outlook.
The contrast with the US remains stark. While higher US yields are being driven by resilient growth, firm inflation and expectations of tighter monetary policy, rising European yields increasingly reflect fiscal risk premia. That divergence continues to favour the dollar and has become a key headwind for EUR/USD.
Positioning is undeniably bearish, with both speculative accounts and options markets heavily skewed against the single currency. However, extreme positioning alone is unlikely to trigger a meaningful rebound. With risk sentiment deteriorating, bond markets under pressure and fiscal concerns still unresolved, further EUR/USD weakness towards the 1.11 area remains the path of least resistance.
GBP: Europe makes sterling look good
In an address to MPs yesterday, PM Andy Burnham reiterated his commitment to deepening ties with the EU, framing the effort as a “duty”. He added that a summit with EU leaders is scheduled for 20 November to sign off on agreements covering food standards and energy markets.
He struck a more “pragmatic” tone on bringing the UK closer to the EU, contrasting with previous interviews where he suggested he would consider joining the customs union, the single market, or even go “all the way” and pursue re-entry.
Regardless of the lack of clarity, and perhaps with some deliberate restraint to avoid stirring tensions within government, the “getting closer to Europe” story could prove sterling-positive heading into 2027. The main channel would be a stronger growth outlook, which in turn would help underpin the UK’s fragile fiscal position.
Sterling was largely unmoved by the comments. The energy shock remains a much more pressing near-term issue for markets to become significantly more optimistic on the UK’s economic and fiscal outlook.
GBP/EUR reached a 12-month high yesterday as the euro continues to suffer from France’s fiscal woes. Relative to Europe, the UK’s fiscal backdrop currently looks more stable. In our view, fiscal turmoil in France is another reason investors may be less inclined to punish UK assets following the autumn budget.
We remain constructive on sterling in the near term and see GBP/EUR firming above 1.18 in the coming days.
On the data front, it’s a quiet week, but the MPC speaker calendar is busy. Today brings Greene, while Pill and Bailey are due later in the week. Markets are pricing nearly a 90% chance of a BoE rate hike in November, and hawkish rhetoric should continue to support sterling.
Market snapshot
Table: Currency trends, trading ranges & technical indicators
Key global risk events
Calendar: October 12-16
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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.
