Dollar Strengthens After Powell, but Outlook Remains Soft

The US dollar firmed following Federal Reserve Chair Jerome Powell’s remarks, though the longer-term outlook remains subdued. Meanwhile, US equities hit new records, with the S&P 500, Nasdaq 100, Dow Jones, and Russell 2000 all closing at historic highs simultaneously – a rare occurrence that suggests confidence is spreading beyond mega-cap tech stocks into smaller companies.

Markets initially reacted to the Fed’s policy statement and revised dot plot as dovish. Short-term yields fell, the dollar weakened, and risk appetite improved. However, Powell’s press conference shifted sentiment. He described the 25 basis point rate cut as a “risk-management” measure, downplayed the likelihood of a larger reduction, and avoided labelling inflation as “transitory.” Following his remarks, two-year swap rates climbed, the yield curve steepened, and the US Dollar Index (DXY) not only recovered earlier losses but posted its strongest daily gain in several weeks.

This rebound, however, appears more like a positioning squeeze than a lasting trend. The Fed has clearly signalled a shift towards supporting employment, and falling funding costs make hedging against dollar strength cheaper. Seasonal headwinds into year-end also point to potential dollar weakness. Analysts still anticipate two additional 25 basis point cuts this year, with the dollar expected to drift lower once markets fully digest Powell’s message.

Yen Gains as BoJ Signals Possible Hike

The Japanese yen outperformed among G10 currencies after the Bank of Japan indicated a firmer policy stance. Two members dissented at the latest meeting, prompting traders to price in a higher probability of an October rate hike.

Euro Pulls Back After US Data

EUR/USD eased by 0.2% on Thursday after US jobless claims came in stronger than expected, helping the dollar regain ground. Earlier in the week, the euro had climbed to near 1.1920 as the Fed’s expected easing cycle boosted sentiment.

Market positioning, as measured by risk reversals, reached levels not seen since early August, reflecting optimism about continued euro strength. However, Powell’s press conference triggered a modest adjustment in the two-year US OIS curve, curbing some of these bets. Despite this, the euro is on track for a weekly gain of around 0.3%, with support holding above 1.18, provided US data do not surprise to the upside.

The euro’s momentum remains heavily influenced by US developments rather than domestic factors. With the ECB having concluded its easing cycle and policy guidance unchanged, near-term movements will largely depend on US yields and the dollar’s trajectory.

Sterling Slides Following Bank of England Meeting

The pound weakened after the Bank of England’s September meeting delivered no surprises. The Bank Rate was held at 4%, with a familiar 7–2 split as two members supported a modest cut. GBP/USD now trades just above 1.35, down from two-month highs above 1.37 earlier in the week.

The BoE also confirmed a slower pace of quantitative tightening, reducing its annual target to £70 billion and indicating future sales would focus on shorter-dated gilts to minimise long-end volatility. While a sensible approach, this reinforced a cautious tone rather than providing support for sterling.

Sterling’s decline late in the session reflected what the Bank did not signal. With no fresh guidance, traders adjusted positions, and sentiment was further weighed down by disappointing August borrowing figures, which showed public sector net borrowing at £18 billion – the largest August print in five years.

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