US Dollar Regains Momentum as Monetary Policy and Politics Collide

USD
The US dollar surged on Monday, posting its strongest daily gain of the month with a near 1% rise against a basket of major currencies. This sharp rebound came after earlier weakness following Chair Jerome Powell’s dovish remarks at Jackson Hole. However, investors now appear to be re-evaluating the broader outlook. Powell’s acknowledgement of a higher neutral rate suggests a shift away from the post-crisis era of persistently low interest rates. While markets initially interpreted his comments as dovish, sentiment is turning towards the view that the long-standing “low for long” narrative may be coming to an end.

Dollar strength was further bolstered by speculation that Governor Christopher Waller could become the next Federal Reserve Chair. Waller’s pragmatic stance and growing support in betting markets have reassured investors concerned about central bank credibility. Still, tensions between the White House and the Fed remain, with President Trump’s attempts to remove Governor Lisa Cook raising fears of political interference.

On the rates front, short-dated maturities remain under pressure as labour market weakness shows through, although political disputes may slow the adjustment. Longer-dated yields are expected to climb further, creating a steeper yield curve that could eventually weigh on the dollar’s rally.

GBP
Sterling weakened against the dollar on Monday, with GBP/USD slipping below $1.35 and trading between its 21- and 50-day moving averages. Against the euro, the pound dropped to a two-week low of €1.1523, although expectations of further euro weakness may offer some support ahead.

Domestically, UK real interest rates have collapsed over the past year, plunging from 3.3% in September 2024 to just 0.2% today. With inflation rising and successive Bank of England (BoE) rate cuts, returns for investors have eroded sharply, leaving the pound at a disadvantage compared with currencies backed by stronger real yields. Governor Andrew Bailey used his Jackson Hole remarks to highlight the “acute challenges” facing the UK economy, including slowing growth and a shrinking workforce due to demographic shifts and weaker post-pandemic participation.

The options market reflects this caution, with traders extending bearish bets on sterling for eight consecutive sessions despite an almost 2% gain in August. With no major UK data releases this week, month-end flows are likely to dominate, while thin August liquidity could trigger sharp volatility in GBP pairs.

EUR
The euro also stumbled at the start of the week, falling 0.7% against the dollar as political tensions in France rattled investors. Prime Minister François Bayrou faces a crucial confidence vote on 8 September over his controversial €44 billion austerity package, with opposition parties determined to block it. French bond yields have jumped to their highest level since March, with spreads over German bunds widening significantly – intensifying pressure on the single currency.

The euro is further weighed down by fading hopes of progress in Ukraine and lingering trade disputes. Powell’s dovish tone at Jackson Hole offered little lasting support, and while markets have priced in around 21 basis points of Fed easing for September, fragile sentiment and French political risks continue to cap euro upside potential.

Looking ahead
Attention now turns to the US PCE inflation data due Friday, with today’s consumer confidence figures offering an early indicator. A softer PCE print could push EUR/USD towards the 1.17 level, but sustained gains remain uncertain amid Europe’s political headwinds and a fragile US outlook. Month-end positioning and the upcoming US holiday suggest heightened volatility across major FX pairs – with liquidity as much a driver of price swings as economic fundamentals.

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