US exceptionalism could be returning as a dominant theme

The US outperformance narrative is back in the fray.

Dollar aversion has been a key theme of the past twelve months or so, largely driven by discontent with erratic US policy, yet throughout that period the US’s economy has remained relatively resilient. Economic growth has been strong, the labour market has held up well despite a period of concern, and American equities continue to surge. The recent hawkish pivot at the Federal Reserve has reassured markets of the central bank’s independence too, as well as raising the likelihood of a higher-yielding USD. Collectively, that has seen the dollar rise to multi-month highs against many of its peers, and it lags behindonly the commodity-exporting AUD and NOK in the 2026 G10 FX rankings. EURUSD fell to a one-year low 1.1325, while GBPUSD slumped to a year-to-date low of 1.3140.

Politics remains in focus either side of the Atlantic.

The USD still has much of its 2025 losses to unwind andtherefore could strengthen a good deal more from here were the exceptionalism trade to really return. However, our economists are projecting difficulty for the USD this autumn with the midterm elections looming –they expect EURUSD to climb back to 1.1900 in the coming months. Meanwhile in the UK, 10 Downing Street looks set to see its seventh prime minister in ten years, with Andy Burnham’s ascension to the top job seeming increasingly likely. What that means for gilts and sterling is a key question on the market’s lips, with particular interest in the Chancellor to occupy 11 Downing Street too. Burnham promises respect for the fiscal rules, butif gilt markets disagree it could spell trouble for the pound, which so far feels to be trading on the optimistic side of life. Sterling reached its strongest level versus the euro since August.

Sources: Investec, Macrobond, Bloomberg

Conflict de-escalation has cooled rate hike bets.

The ECB raised interest rates in June, a year and five days after concluding its rate cutting cycle. On balance markets still expect another increase this year,but that likelihood has certainly been reduced following the climbdown in energy prices. The US-Iran Memorandum of Understanding appears to have been enough to recover risk sentiment almost entirely, and a Bank of England rate hike is no longer fully priced in for 2026. Due to the recent fall in energy futures prices, our economists have reduced their expected peak of UK CPI inflation from 4.0% to 3.1%. By contrast, Kevin Warsh’s first meeting as Federal Reserve Chair delivered a hawkish surprise, prompting expectations of US rate increases, as opposed to cuts as the market had forecast just ten weeks ago. Cross-Atlantic interest rate differentials have seen a two-sided pivot, adding to the USD’s recent strength. Markets imply no change in G3 interest rates at this month’s meetings.

Yen weakness continued through June.

The Japanese authorities’ intervention in late-April has now ben more than unwound, after USDJPY traded at 161.95 and therefore matched 2024’s post-1986 high. That is despite continued speculation around possible further intervention, and another interest rate increase from the Bank of Japan. Yen traders will remain twitchy and on the edge of their seats while we continue to trade at such levels. Elsewhere, the NOK and AUD gave back more of their gains as a) commodity prices continued to fall, and b) the USD’s hawkish pivot takes some of the high-yielding shine off the Aussie dollar and the krone. The risk sentiment recovery also helped many emerging market currencies, including the South African rand and the Mexican peso. GBPZAR now trades in the mid-to-high-21.000s, not far from February’s three-year low.

Sources: Macrobond, Bloomberg, Investec
Chart data as of: 13:00 BST, Wednesday 1 July

Forecasts

Sources: Investec, Macrobond, Bloomberg

Sources: Macrobond, Bloomberg, Investec

Sources: Macrobond, Bloomberg, Investec

Notes: Forecasts are produced by Investec Economics and are for end-quarter
Chart data as of: Saturday 27 June