USD: Dollar strength beyond hawkishness
The dollar rally appears larger than what a hawkish tilt alone would justify, with several factors at play. Notably, rate pricing has failed to reinforce the move this week, with 2Y OIS declining by around 7bps since Monday and year-end hike expectations easing from 42bps to around 35bps.
Technical dynamics have been important, with key levels breached this week, including DXY at 100 to 100.50 and EUR/USD breaking below 1.14. This has triggered follow-through buying as a clear breakout from a months-long range emerged. A tech-led equity sell-off has also contributed, as a refreshed safe-haven bid in the dollar emerged amid growing caution around the AI trade.
Warsh’s press conference at the Fed policy meeting last week has also been a relevant catalyst. A steady rise in real yields, following a run of strong macro data, coincided with declining term premia, the extra compensation investors demand for holding duration risk. Lower oil prices have helped reduce inflation uncertainty, while the Fed’s messaging has reinforced policy credibility, allowing term premia to compress further. In this context, the US dollar was poised to move higher, supported by rising real yields pointing to solid fundamentals and compressed term premia signalling much needed policy credibility. In this context, the US dollar was poised to move higher, supported by rising real yields pointing to solid fundamentals and compressed term premia signalling much needed policy credibility.
Today sees the release of the PCE report, expected to edge higher to 4.1% in May from 3.8%, the highest since 2023. Given how fresh the hawkish Fed theme has been in recent days, an in-line outcome would likely reinforce hawkish bets, bringing the bias closer to two hikes this year after having stalled this week. In that case, 101.200 becomes a clear upside target.
EUR: Divergence depressing the euro
The euro’s narrative has shifted materially over the past month. EUR/USD is down more than 2.5% month-to-date, putting it on track for its largest monthly decline in almost a year, as interest rate differentials have reasserted themselves as the dominant FX driver.
The backdrop has become increasingly unfavourable for the common currency. Persistent US inflation pressures and relatively resilient economic data have reinforced expectations of a more hawkish Federal Reserve, while softer eurozone growth and cooling price pressures have reduced the need for further aggressive ECB tightening. The result is a widening policy divergence that is increasingly working in the dollar’s favour.
Part of the ECB’s shift also reflects growing optimism that a lasting US-Iran agreement could keep energy prices contained. Lower energy costs would ease inflation pressures across the eurozone and improve the region’s terms of trade. Arguably this should be supportive for the euro. However, with markets once again focused primarily on relative rates, the impact has been overshadowed by the Germany-US two-year rate spread widening to its most dollar-supportive level since September.
Positioning markets are reinforcing the same message. Both short- and long-dated FX options have become increasingly skewed toward further euro weakness, suggesting investors see the move as more than a temporary correction.
The technical picture has also deteriorated. EUR/USD has broken below 1.14 and is testing support around 1.1340, a level highlighted in yesterday’s report. While the sell-off is beginning to look stretched and could pause if today’s US inflation data surprise on the downside, the broader path of least resistance appears lower. With growth, yields, central bank rhetoric and market positioning increasingly favouring the dollar, EUR/USD risks settling into a 1.11–1.15 trading range during early Q3, unless a new catalyst emerges to revive euro demand.
GBP: GBP dragged by USD strength
Amid declining oil prices, with Brent dropping below $75, its lowest since the conflict began, investors have pared back bets on BoE hikes this year, now pricing just under one hike by December. GBP/USD fell to November 2025 lows near 1.3150, though much of the move was driven by broad-based dollar strength (see USD section above).
Meanwhile, GBP/EUR was broadly flat into yesterday’s close, up around 0.5% so far this week. The recent erosion in both the ECB’s and the BoE’s hawkish stance has failed to generate clear directional momentum for the pair. At the same time, markets continue to look through Starmer’s resignation. Efforts by Starmer and the broader Labour Party to ensure a smooth transition to Burnham have helped contain sterling downside, with figures once seen as potential contenders now signalling support for the Mayor of Greater Manchester, marking another step toward an orderly handover.
Looking ahead, GBP/USD direction will largely depend on today’s US PCE report. A hot print would likely see the pair test 1.31.
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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.
