Dollar Backed by Geopolitics and Fed Expectations
The US dollar remains supported by expectations of further Federal Reserve tightening and ongoing Middle East hostilities, while EUR, GBP and CAD remain sensitive to energy prices and broader market sentiment.
USD
The US dollar entered the week close to seven-week highs, supported by last week's 25bp Federal Reserve rate increase and expectations that policymakers may tighten further before year-end. The Fed raised rates on 16 September, taking the Fed funds target range to 3.75%-4.00%, while updated projections pointed to a meaningful possibility of another move before year-end. At the same time, ongoing hostilities in the Middle East continue to underpin demand for safe-haven assets. Reports of attacks on shipping near the Strait of Hormuz have reinforced concerns over energy supply disruption, supporting the dollar and maintaining a cautious tone across broader financial markets.
Today's US calendar is relatively light, leaving markets focused on Fed expectations, Treasury yields and geopolitical developments. Attention will increasingly turn to this week's flash PMI surveys, which should provide an important indication of whether US economic momentum remains resilient despite tighter financial conditions. Consistent with our Week Ahead outlook, we continue to favour the dollar as quarter-end approaches. As long as geopolitical tensions remain elevated and markets continue to price the possibility of further Fed tightening, the greenback should remain well supported.
EUR
The euro recovered modestly towards the end of last week as oil prices eased following indications that part of Saudi Arabia's damaged East-West pipeline capacity could be restored within days. As immediate concerns over energy supply disruptions moderated, EUR/USD finished last Thursday just below 1.15. Despite the recovery, the single currency remains highly sensitive to developments in energy markets, reflecting the Eurozone's reliance on imported energy and the potential economic impact of further supply disruptions.
Attention will now turn to this week's flash PMI surveys, which will offer a timely assessment of the region's economic resilience. Although the ECB delivered a 25bp rate increase earlier this month, higher rates have provided only limited support for the euro as investors remain concerned about the consequences of elevated energy costs and weaker growth prospects. We continue to expect ongoing hostilities in the Middle East to remain a key driver of EUR performance. Any renewed escalation that pushes oil prices higher would likely create additional headwinds for the Eurozone economy and reinforce the current dollar-supportive environment.
GBP
Sterling underperformed its major peers following last Thursday's Bank of England decision. The MPC left Bank Rate unchanged at 3.75% in a 6-3 vote, although the accompanying communication carried a distinctly hawkish tone. Policymakers revised inflation projections higher and highlighted the risks posed by elevated energy prices. Nevertheless, GBP/USD traded in the mid-1.33s by the end of last week as markets focused on the comparatively stronger policy outlook from the Federal Reserve.
This morning's UK public sector finances release provided the main domestic focus for sterling. The ONS reported public sector net borrowing of £18.3bn in August, up £2.9bn from the same month last year and £3.5bn above the OBR forecast. Borrowing in the financial year to August reached £77.3bn. While this was £2.2bn lower than the same period last year, it remained £8.1bn above the OBR forecast. The figures are unlikely to alter the Bank of England's near-term policy outlook, but they reinforce investor focus on the UK's fiscal position and potential gilt issuance requirements ahead of the Autumn Budget.
External factors are nevertheless likely to remain the primary drivers of sterling. Energy prices, US rate expectations and ongoing hostilities in the Middle East continue to dominate market sentiment. Sustained geopolitical tensions and higher oil prices present a challenging backdrop for the UK economy, adding to inflation risks while potentially weighing on growth. In the near term, sterling is likely to remain sensitive to broader dollar movements, while investors continue to assess whether recent MPC rhetoric ultimately translates into stronger expectations for further Bank of England tightening before year-end.
CAD
The Canadian dollar entered the week caught between softer oil prices and ongoing US dollar strength. Towards the end of last week, crude prices eased after reports that Saudi Arabia could restore part of its disrupted pipeline network, reducing some of the immediate support typically provided to commodity-linked currencies. As a result, USD/CAD remained close to the 1.40 area. At the same time, stronger Canadian producer price data highlighted that higher energy costs continue to feed into the domestic economy, although markets still expect the Bank of Canada to leave policy unchanged in the months ahead.
Looking ahead, CAD remains heavily influenced by developments in crude oil markets and broader US dollar dynamics. The ongoing hostilities in the Middle East continue to create uncertainty around global energy supplies, demonstrating how quickly geopolitical risk premiums can return even after signs of improving infrastructure capacity. With the domestic calendar relatively quiet, we expect oil prices, geopolitical developments and US rate expectations to remain the primary drivers of CAD price action this week. While elevated energy prices may provide support for the loonie, persistent US dollar strength could continue to cap gains.