Key Takeaways
- US inflation rose unexpectedly, leading to a temporary dollar surge but retracing as expectations for a Fed rate hike remain unchanged.
- The euro faces challenges, including widening rate differentials favoring the dollar and fiscal concerns in France, putting pressure on EUR/USD.
- UK GDP grew unexpectedly, boosting confidence in the economy and supporting a hawkish outlook from the Bank of England.
USD: Dollar climbs to 18-month high after CPI surprise, trims gains later
US September inflation came in hot yesterday. Headline CPI rose 0.6% m/m, the fastest pace in five months, while core inflation surprised to the upside at 0.3% versus expectations of 0.2%.
Front-end Treasury yields surged in response, with the 2-year rising as much as 15bp at one point during the session and dragging the broader curve higher.
The dollar rallied too, with DXY taking out its 12 October high of 102.607 and pushing toward the 103 mark.
The moves have proved short-lived, however. Treasury yields are retracing some of yesterday’s rise, suggesting the hotter inflation print has not materially shifted expectations for a more aggressive Fed hiking path. Remarks earlier this week from Fed’s Williams, who said he could see one more rate hike this year followed by an extended pause into 2027, may have already helped cement expectations in that direction.
It may also be that, with yields sitting at multi-decade highs, investors are reverting to the old playbook of selling equities and buying safe-haven bonds. Fixed-income returns remain attractive after months of heavy sell-offs, while optimism around equities remains restrained amid earnings season. Even so, we would expect this setup to be temporary and see further selling pressure on Treasuries to resume as AI-related jitters subside.
A separate report yesterday showed that inflation-adjusted average hourly earnings fell in September from a year earlier for a sixth consecutive month.
That is unlikely to be welcome news for the Trump administration just weeks ahead of the midterm elections. The cost of living remains a top concern for voters heading to the polls.
A Republican setback, with Democrats potentially taking control of both the Senate and the House, remains a possibility. We do not expect the dollar to react materially to the election outcome itself in the near term, however.
A still-hot economy, a hawkish Fed, and persistent geopolitical tensions remain powerful supports for the greenback, insulating it from any Trump-related political risk premium for now.
Today brings the release of the PPI report, a snapshot of prices charged by wholesalers to retailers. With much of the upside surprise in consumer prices driven by energy, a strong PPI print looks likely. This should keep the dollar supported, with the DXY holding above 102.
EUR: Flirting with key support
The euro remains under pressure following yesterday’s hotter-than-expected US inflation report, with EUR/USD falling to fresh lows last seen in May 2025. The pair is now testing the 200-day moving average near 1.11, a key technical level that could determine whether the recent sell-off extends further or finally begins to stabilise.
The challenge for the euro is increasingly two-fold right now.
First, Fed-ECB rate expectations are moving further in the dollar’s favour. Markets continue to add to Fed tightening expectations after stronger US inflation data, while the ECB’s path looks less certain. Recent remarks from President Lagarde highlighting the absence of meaningful second-round inflation effects, alongside growing concerns over tightening into a weaker growth environment, have tempered expectations for how far the ECB can ultimately go. The result is a widening rate differential that continues to support the dollar.
Second, French fiscal concerns remain an important euro headwind. While the French-German 10-year spread narrowed modestly earlier this week, the broader issue remains unresolved. European yields are increasingly rising for fiscal reasons rather than growth reasons, creating a very different dynamic from the US. Higher Treasury yields reflect resilient growth and inflation; higher European yields increasingly reflect fiscal risk premia.
The result is a difficult backdrop for the single currency. Elevated energy prices, widening real rate differentials, political uncertainty and resilient US economic data are all reinforcing the dollar’s appeal. While EUR/USD is becoming stretched on some technical measures, there is little evidence yet of a catalyst capable of generating a sustained recovery.
For now, the path of least resistance remains lower, with the 1.11 area emerging as the next key battleground for EUR/USD.
GBP: UK resilience reinforces BoE bets
This morning brought the release of the UK’s monthly GDP figures, which surprised to the upside relative to expectations for a 0.1% contraction in August. Instead, the UK economy grew by 0.1%.
While a single monthly print tells us little, the broader trend this year has been encouraging. In its latest World Economic Outlook, released this week, the IMF upgraded the UK’s growth outlook, noting that GDP expanded by 0.5% in Q2 2026 after growing 0.6% in Q1.
The Fund highlighted more diversified supply chains and AI-related investment as key reasons behind the UK’s resilience this year, despite higher energy prices stemming from tensions in the Middle East.
While long-term growth risks remain significant amid rising borrowing costs, a more resilient UK macro backdrop should help shield sterling from lingering fiscal concerns ahead of the upcoming UK budget.
On the monetary policy front, Governor Bailey and Chief Economist Pill both struck a moderately hawkish tone yesterday. Bailey noted that second-round inflation effects remain subdued, although the risk of them materialising increases the longer the conflict persists. Meanwhile, Pill pushed back against the roughly 100bp of hiking currently priced over the coming year, arguing that more “concrete evidence” on inflation would be needed to justify such a path.
That said, he acknowledged that the Bank could have responded sooner to the energy shock linked to the conflict, suggesting that an earlier move would have demonstrated the BoE was not simply “holding and hoping”.
There remains a degree of constructive tension between the two officials. Bailey has maintained a patient stance for months, while Pill comes across as somewhat regretful of not having acted sooner.
Bailey may be the swing vote here, but markets are steadily gravitating towards the hawkish camp, with the odds of a rate hike next month climbing above 90%, up from around 80% at the start of the month.
We remain constructive on sterling in the near term, supported by growingly hawkish BoE expectations, a more resilient macro backdrop, and cautious optimism around the new administration’s efforts to improve the UK’s fiscal outlook.
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.
