Dollar Holds Firm as Markets Await the Federal Reserve

The US dollar is holding steady as global investors await a pivotal Federal Reserve meeting this week. The S&P 500 continues to demonstrate remarkable resilience, notching four record closes in just eight sessions this month. Optimism around a potential “soft landing” and the strength of major technology stocks remain key drivers, although caution is creeping in across bond markets.

Since mid-July, yields on both ten- and thirty-year US Treasuries have drifted lower, signalling expectations of softer growth ahead. The spread between thirty- and ten-year yields currently sits at 0.64% — above its long-term average of 0.49% — a reflection of concern that the economy may be slowing faster than anticipated.

Fed Meeting in Focus

Attention now shifts to the Federal Reserve, where markets widely expect an interest rate cut that is already largely priced in. Traders anticipate at least three cuts this year, though sticky inflation remains a risk, particularly as the impact of tariffs feeds through the economy. Should inflationary pressures re-emerge, the Fed may be forced to pause after its first move — a scenario that could put pressure on equity markets.

While stagflation is not yet evident in the data, it remains a risk to watch closely.

The prospect of policy easing has weakened the greenback, with the Dollar Index (DXY) down 2.7% since the beginning of August. Yet volatility has remained muted, with the DXY trading in a narrow 97–99 range. Markets appear to be waiting for a catalyst — either a spike in inflation or a sharp slowdown in hiring — to break the current calm. If confidence in a soft landing fades, the dollar could benefit from renewed safe-haven flows.

This week’s meeting promises to be lively, with Fed Chair Jerome Powell expected to face tough questions on inflation pass-through, labour market weakness, central bank governance, and his recent Jackson Hole remarks. Markets will be watching closely for signals on how the Fed balances inflation control with supporting growth as it begins a new easing cycle.

Euro Eyes Further Gains

The euro’s path towards 1.20 against the dollar remains tied to developments in the US. Softer American data and expectations of Fed cuts have fuelled EUR/USD’s rally, while the European Central Bank (ECB) appears comfortable pausing for now. Euro strength could receive a further boost if fiscal policy starts to lift eurozone growth, though ongoing trade tensions present a downside risk.

Since so-called “liberation day”, the euro has been the preferred vehicle for expressing dollar scepticism, advancing more than 10%. However, risks remain within the bloc. France’s political turmoil prompted a Fitch downgrade last week, though President Macron’s appointment of a centrist prime minister has steadied investor nerves, keeping the French–German yield spread contained.

ECB President Christine Lagarde reaffirmed last week that current rates are appropriate, with no urgency for additional easing. This stance has helped anchor EUR/USD closer to relative yield spreads. Over the coming days, eurozone trade figures, industrial output, August inflation data, and the ZEW surveys will provide key insight into whether the euro can extend its rally or whether domestic risks will cap upside potential.

Sterling Supported by Bank of England Stance

Sterling continues to draw support from the Bank of England’s hawkish policy stance, even as the UK economy shows signs of strain. Recent data, including weaker industrial production and sluggish GDP growth, highlight ongoing fragility. Fiscal uncertainty is also rising ahead of the autumn budget, with speculation mounting over possible tax increases.

In the short term, GBP/USD remains underpinned by the policy divergence between the BoE and the Fed. While the Fed is expected to cut rates this week, the Bank of England is forecast to hold steady, with inflation still uncomfortably high and its pace of loosening expected to remain gradual — likely one cut per quarter.

This week brings two key data releases: UK employment figures on Tuesday and CPI inflation on Wednesday. While neither is expected to trigger an immediate policy shift, both will shape market expectations for the next move, with November seen as the likely timing for a cut. Against the euro, sterling closed last week only modestly higher, reflecting softer UK data. For now, high short-dated gilt yields continue to make the pound an expensive sell relative to the euro.

Sterling’s near-term steadiness rests on the BoE’s hawkish stance. Yet structural headwinds — sluggish growth, fiscal pressures, and the looming risk of rate cuts later in the year — leave the balance of risks skewed to the downside.

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