USD resilient as Fed inflation concerns offset risk recovery

The stalemate in the Middle East continues

The lack of escalation and tentative movement towards a deal have, however, buoyed market sentiment. Broader financial markets have seen part of their conflict-driven moves unwind - bonds rallied, oil prices fell, and equities continued their march higher. The USD however, has performed fairly well. That is partly because the dollar hadn't strengthened all that much in the first place, but also because the narrative at the Federal Reserve has shifted somewhat of late. Despite Kevin Warsh’s swearing in as the new Chair, US monetary policymakers are sounding increasingly concerned about the inflation outlook. Markets are now pricing in a good chance of a rate increase this year, which has supported the USD recently.

In Europe, an ECB rate increase looks highly likely

Eurozone CPI inflation has risen to its highest since September 2023, owing to elevated energy prices. The Federal Reserve’s and the Bank of England’s policy rates remain in restrictive territory, meaning taking expected cuts off the table has passively tightened UK and US monetary policy to an extent. European Central Bank interest rates sit around ‘neutral,’ however. Our economists therefore think Christine Lagarde & co. will be more ready to raise rates in response to the energy price shock – they expect 25 basis point rate increases both this month and next. That could give support to the euro, which they foresee gaining slightly versus sterling and returning to 1.2000 versus the dollar by the end of the year.

Notes: solid lines show current market pricing; faded lines show pricing from 4 May and 27 Feb
Sources: Macrobond, Bloomberg, Investec

Makerfield’s by-election is sterling’s key focus this month

Greater Manchester Mayor Andy Burnham has partly reassured gilt markets. Showing respect for the existing fiscal rules has comforted investors that his potential ascension to 10 Downing Street would not erode the UK’s remaining fiscal credibility. Sterling has therefore recovered too, after a nervy moment in mid-May, returning to near the middle of the recent tight ranges against the euro and the USD. In fact, measured in pips, the last 12 months’ GBPUSD range is the narrowest in the modern FX era, per Chart 2. The by-election still poses as a risk event however, given both the uncertainty surrounding the victor and the subsequent implications for policy. For now, options markets still show underlying sterling bearishness.

The sleepwalking yen has unwound its intervention gains

Following the Japanese authorities’ near $75bn spend on strengthening the JPY in the last two months, the currency has steadily weakened back towards its lows. The Bank of Japan meeting on 16 June is the next key date for the yen, where any disappointment to the market’s bets on a rate hike would likely spell another bout of yen selling. Elsewhere, the rand and the forint unwound more of their losses on buoyed sentiment, while the AUD and NOK remain the outperformers in G10 FX. The Australian and Norwegian central banks look less likely to raise their interest rates this month though, after recent hikes. The Reserve Bank of New Zealand is the only G10 currency central bank not announcing a policy decision in June – a Kiwi rate hike is expected in July.

Sources: Bloomberg, Macrobond, Investec

Forecasts

Sources: Macrobond, Bloomberg, Investec

Sources: Macrobond, Bloomberg, Investec

Sources: Macrobond, Bloomberg, Investec

Notes: Forecasts are produced by Investec Economics and are for end-quarter
Chart data as of 10:04 BST, Wednesday 3 June 2026