Dollar Holds Steady as Fed Strikes Cautious Balance

USD Outlook
The US dollar index edged higher after Federal Reserve Chair Jerome Powell signalled that the path to interest rate cuts remains far from straightforward. Powell emphasised the delicate balance of controlling inflation while the labour market shows early signs of slowing. Meanwhile, newly appointed Fed Governor Stephen Miran, who advocated a more aggressive 50-basis-point reduction last week, cautioned that misjudging policy restrictiveness could risk job losses if the Fed fails to act decisively.

Recent US economic data offered mixed signals. The purchasing managers’ index (PMI) for September missed expectations, with the composite index falling to 53.6 from 54.6 (consensus: 54). Employment held steady at 51.7, and new orders came in at 53.1, still indicating expansion. Input costs rose while output prices eased, suggesting margin pressures but not enough to sway market expectations. Following Powell’s comments, investors have scaled back bets on further rate cuts this year, supporting the dollar’s modest recovery.

The narrative surrounding the dollar is shifting. Rather than being driven solely by falling interest rates, the currency is increasingly seen through the lens of relative US growth. After a sharp decline in the second half of 2024, markets now anticipate a terminal rate near 3%. While growth momentum has eased since pandemic highs, calmer tariff volatility, loose financial conditions, and increased fiscal support via the so-called “One Big Beautiful Bill” could position US growth favourably in 2026.

GBP Update
The UK economy lost momentum in September, with PMI data signalling the sharpest slowdown in private-sector activity since April. Services growth eased, and manufacturing contracted more sharply, pulling the composite index down from a one-year high to a four-month low. Sterling initially dropped to an eight-week low against the euro before staging a mild recovery, while against the dollar it hovered just above $1.35 – a level rarely surpassed in the last decade.

Domestically, the UK faces a more uncertain outlook. Softer data and fiscal concerns have left sterling heavily reliant on dollar weakness. The correlation between UK and US two-year yields and GBP/USD has strengthened, with the spread widening to a two-year high of 46 basis points, supporting sterling’s 8% year-to-date gain. However, fiscal risks remain significant. Rising debt burdens and strong demand for downside protection in sterling options point to a fragile backdrop.

The OECD’s recent forecast adds to caution, projecting only 1.0% UK GDP growth in 2026. After outperforming in 2023 and 2024, the economy and sterling have lost ground in 2025. The government faces a £30 billion budget shortfall, likely to be addressed through higher taxes rather than spending cuts. This ongoing uncertainty dampens investment and investor sentiment. Sterling’s gains versus the dollar this year primarily reflect US weakness, and even so, they lag behind European peers such as the Swedish krona and Swiss franc.

EUR Performance
The euro remained just below $1.18, with traders hesitant to push higher without clearer guidance from the Fed. While a short-term move above $1.18 is possible, sustained gains would require stronger US policy signals.

Eurozone PMIs were mixed. Manufacturing fell to 49.5, signalling contraction against forecasts of 50.7, while services remained resilient, keeping the composite index at 51.2. Service-sector strength is helping offset manufacturing weakness, though the bloc’s export-dependent economy remains vulnerable to global trade uncertainties.

Attention now turns to US PCE data due this Friday. A softer-than-expected reading could give the euro a temporary boost past $1.18. However, given the Fed’s cautious stance, any rally may be short-lived.

Looking Ahead
Currency markets are increasingly being shaped by relative growth prospects and fiscal positions as much as central bank policy. The dollar appears to be establishing a floor as US growth resilience challenges bearish market sentiment. Sterling’s trajectory will hinge on the UK government’s November budget and whether it can restore investor confidence. For the euro, moderate service-sector growth provides support, but global trade conditions and Fed policy will dictate near-term direction.

For all you Global payments & currency conversion solutions go to Monfor