Political uncertainty sends ripples through FX markets

Euro bears the burden of political uncertainty

Our economists have flagged the risk of French politics for the euro for some months now, but they had anticipated a knock in Q1 next year ahead of the presidential election. Instead, things have taken a turn for the worse in the past couple of weeks, as reining in the budget deficit with such a fragmented National Assembly looks increasingly difficult. In addition, that difficulty risks polarising politics even further and raises the possibility of either a far-left or far-right party gaining power. Bond yields have risen globally, but French government bond yields by even more so – the French risk premium vis à vis German bonds rose to its widest in 15 years this week. EURUSD fell to a one-year low of 1.1161, while GBPEUR reached a new one-year high. French bonds have recovered in the last few days, but the issue certainly remains in the spotlight. FX options markets are more euro-bearish than they have been for some time.

Higher Treasury yields are adding to USD strength

In contrast to European bond yields and the euro, higher sovereign bond yields are helping the dollar, or are at least coinciding with a stronger dollar. While investors are concerned by the US’s fiscal sustainability and debt service costs too, the repricing of the Federal Reserve interest rate outlook has been USD-positive. Energy prices have been a key factor behind the shift of course, but economic resilience has been another factor, as well as a reassuring pivot from Fed Chair Kevin Warsh from a credibility standpoint. Bloomberg’s DXY dollar index rose to a 17-month high this week, marking its highest level since the mid-April 2025 ‘Liberation Day’ related dollar sell off. The midterm elections next month are now a focal point. This last month has seen a sharp rise in the probability of a Democratic clean sweep across Congress, which could trigger volatility if it came to pass.

Sources: Investec, Macrobond, Bloomberg

A ‘do no harm’ Budget looks in store for the UK

As our economists have pointed out, Labour’s recent recovery in the polls is something Chancellor John Healey won’t want to torch with a politically unpopular Budget. A resilient economic performance so far in 2026 will probably help the Chancellor kick the can down the road when it comes to the toughest of decisions, but the rise in borrowing costs will mean some measures will need to be taken. Sterling falls quite nicely under that ‘do no harm’ bracket with gilts, and so I think the risks to the pound are perhaps more limited this time, barring any major surprises. However, we have a big month of UK economic data in store -  a Bank of England interest rate increase is 85% priced in for the meeting on 5 November. This month’s inflation data and any conflict-driven movement in energy markets will be a key determinant in that rate decision, and subsequently sterling’s fortunes.

The Swedish krona’s woes continued in September

The tightest election result in the country’s history has left lingering uncertainty as a government is still yet to be formed. Meanwhile Swedish GDP data underperformed versus expectations, and energy prices continues to work against the SEK too. Markets are now looking for Swedish rate increases though, which could begin to turn the tide. Meanwhile the NOK and AUD have held up well still, retaining their gains even as risk sentiment took a hit and the USD gained close to 3% versus most of its G10 peers on average. One of the biggest underperformers following that sentiment shift was the Mexican peso, which weakened by around eight percent versus the dollar over the course of September. By contrast, Flávio Bolsonaro’s win in the first round of Brazilian elections saw the BRL jump 4% higher over the course of the weekend just gone, on hopes of a marked fiscal shift.

Sources: Investec, Macrobond, Bloomberg
Notes: uses an equal-weighted index for each currency against the other nine in the G10

Forecasts

Sources: Investec, Macrobond, Bloomberg

Sources: Investec, Macrobond, Bloomberg

Sources: Macrobond, Bloomberg, Investec

Notes: Forecasts are produced by Investec Economics and are for end-quarter
Chart data as of: 12:24 BST, Wednesday 7 October