Dollar Weakens as US Retail Sales Surprise, Spotlight on Fed

The US dollar slipped on Tuesday, despite stronger-than-expected retail sales figures, as markets turned their focus to the Federal Reserve’s upcoming policy decision.

August retail sales rose 0.6%, with the key control group climbing 0.7%, both ahead of forecasts. July’s data was also revised higher, underlining the resilience of household spending even as tariffs, a softer labour market, and persistent price pressures weigh on the economy. A buoyant stock market and expectations of looser monetary policy appear to have bolstered consumer confidence through the summer.

However, the upbeat data did little to shift consensus that the Fed will cut rates at today’s meeting. Because sales are not adjusted for inflation, the figures provide limited evidence against easing, particularly with tariffs still fuelling price pressures. Ahead of the announcement, the US Dollar Index (DXY) dropped nearly 0.7%, edging towards year-to-date lows near 96.38.

Markets view the start of a Fed easing cycle as unusually bearish for the greenback, amid concerns over central bank independence and the risk of a more aggressive policy path under new leadership in 2025. With hedging costs falling, investors continue to buy protection against further dollar weakness. Technical support around 96.60 may hold in the short term, though a cautiously dovish message from Fed Chair Jerome Powell could spark a rebound above 97 if speculative positions unwind.

Euro Pushes Higher Towards Key Resistance

The euro extended its rally, reaching a four-year high against the dollar as traders bet on Fed rate cuts widening the policy gap with the European Central Bank (ECB). The single currency has gained more than 14% year-to-date, mirroring the 2017 rally and tracking yield differentials after last week’s dovish shift in Fed expectations.

Sentiment improved further after Germany’s ZEW economic expectations index climbed to 37.3 in September, signalling tentative optimism despite weak current conditions. Hopes for fiscal stimulus and continued ECB support are fuelling expectations of a modest recovery, though the delayed hit from US tariffs on German exports remains a risk.

From a technical perspective, the euro has cleared an important resistance zone, opening the path towards 1.20. Options data shows steady demand for euro calls, reflecting expectations for another leg higher. Still, Bank of America’s latest survey highlights slowing inflows into European equities, suggesting currency support from asset allocation may wane later this year.

Sterling Holds Firm After Robust Data

The pound sterling strengthened to $1.3672, its highest in two months, after solid UK labour-market data and steady inflation reinforced expectations that the Bank of England (BoE) will keep rates unchanged.

Regular pay excluding bonuses rose 4.8% year-on-year in the three months to July, easing slightly from earlier readings but still above the level consistent with the BoE’s 2% inflation target. Headline inflation rose 3.8% year-on-year, broadly matching forecasts and marking an 18-month high. Markets see only a slim chance of a cut at Thursday’s BoE meeting, helping underpin sterling.

That said, the pound’s position remains fragile. Structural economic headwinds and cautious option-market positioning suggest limited upside beyond this week. While GBP/USD eyes a break above early-July highs near 1.37, much will hinge on the Fed’s tone. A dovish but measured Powell could lend the dollar support, potentially dragging sterling back below 1.36.

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