The bond market remains in turmoil, but this time the is reacting positively. This tentative rebuilding of a USD-back-end yield positive correlation bodes well for the greenback’s short-term outlook. We don’t think the bar is high for today’s to endorse a next week. Still, a hawkish ECB means downside risks may be less pronounced
USD: Not a High Bar to Cement Hike Bets
and both surged yesterday. In G10 FX, the reaction looked more like a rates story than an oil story, propagating through the global risk sentiment channel. The high-beta , and led losses on a strong day for the US dollar, while the more defensive sterling and proved relatively resilient.
The dollar is tentatively re-establishing a positive correlation with long-end yields, helped by a smaller-than-expected $6bn Treasury buyback announcement, which ultimately translated into an even smaller $5.19bn operation yesterday. US Treasury Secretary Scott Bessent’s reluctance to pick a fight with the bond market through oversized intervention remains a necessary condition for that positive USD-back-end rates correlation to regain its footing.
Pricing for next week’s FOMC inched up to 18bp yesterday, buoyed by the oil rally and a modest upward revision to July , while August figures came in exactly on consensus. Today’s August release can provide the green light to fully price a September hike with even a marginal upside surprise. Consensus stands at 0.2% month-on-month for and 0.4% for . That is also ING’s macro team’s expectation, and our assessment is that the acceleration in headline inflation would be enough to tilt the balance towards a hike despite still-benign core dynamics.
The picture becomes more nuanced in the event of a downside surprise. Federal Reserve Chair Kevin Warsh set a high bar for incoming data to overturn the hawkish narrative, but Christopher Waller later suggested no hike would be needed if inflation continued to improve through August. Oil may prove the deciding factor, having rallied around 15% since then. A softer CPI print could weigh on the dollar, but may not be enough to push September hike pricing below 50%, a level we suspect would be sufficient to bring any unconvinced FOMC members on board.
We continue to see upside potential for the dollar. The rally has stalled and is no longer exerting a negative spillover effect on USD. Developments in the Gulf leave the balance of risks skewed towards higher oil prices, while stress in bond markets is increasingly bleeding into risk assets. That combination should favour a defensive rotation back into the dollar. 100.0 is starting to look less like a stretch target and more like a destination.
EUR: Hawkish ECB Reduces Downside Risks for Now
The European Central Bank delivered a hawkish hike yesterday. Inflation projections were revised higher across the forecast horizon, with and seen at 2.1% and 2.3%, respectively, in 2028. Taken at face value, those forecasts already pointed to further tightening. ECB President Christine Lagarde’s press conference added to that impression, and the customary late-afternoon tip to the media removed any lingering doubt: ECB officials expect more tightening, with October firmly in play.
From a rate and FX perspective, however, this meeting was pivotal for the short-term outlook regardless of whether the ECB ultimately delivers another hike this year. The key takeaway is that it effectively gave markets the green light to preserve what is proving to be an almost uncapped correlation between oil prices and rate expectations. Around 85bp is now priced in for July, a roughly 25bp jump compared to pre-meeting.
For that reason, we have trimmed some conviction from our 1.150 EUR/USD call. Even so, while downside risks may now look less acute, they have not disappeared. Our focus remains on the broader risk backdrop this week and on an increasingly likely Fed hike next week, when it may be the dollar’s turn to receive a bullish boost from its central bank.
GBP: Good GDP Not a Game Changer for BoE
Gilts took another blow yesterday, underperforming European peers. The is now eyeing 5.5%, and the is very close to 6.0%. Sterling held up well yesterday, confirming this was a purely externally driven move in gilts (which simply have higher beta to US Treasuries) and not caused by heightened fiscal concerns.
Chancellor John Healey’s pledge to budget discipline is working in that sense. But it equally highlights how limited the room for any pro-growth government measure is. That, among other things, sits at odds with markets’ mammoth bets on monetary tightening: 48bp by year-end, 110bp by July. Our baseline is still that the Bank of England won’t hike at all, leaving sterling in front of a potential cliff-edge dovish repricing.
UK surprised to the upside this morning, rising 0.4% MoM after June’s strong 0.3% gain. Around half the increase came from IT, continuing a familiar trend. With IT accounting for roughly 7% of the economy but contributing a third of the UK’s 1.5% annual growth rate, there may be an AI story emerging here. GBP is a tad stronger on the back of that, but these monthly growth prints have not had much impact on BoE decisions.
We continue to see upside room for and downside for , with 4Q targets of 0.87 and 1.33.
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