The USD gained throughout July...
..breaking out of its downward trend channel. EURUSD and GBPUSD had previously both reached three-year highs, of 1.1829 and 1.3789 respectively. The reasons for the dollar’s rally are three-fold: 1) profit-taking on what was a quick move lower in the USD; 2) some trade deals being agreed, reducing trade policy uncertainty somewhat; and 3) reduced bets on interest rate cuts from the Federal Reserve (Fed). Forecasts remain for the USD to weaken in the medium term, but as investors rebalance their portfolios through the summer it seems some short-term dollar-selling has been unwound. Meanwhile on the tariff front, given the USD’s sharp declines in the wake of Liberation Day, it makes some sense that it pulled a bit back as trade deals were agreed.
Still, some ‘uncertainty scarring’ effects remain for the dollar
The chart to the right shows that EURUSD’s correlation with interest rate differentials broke down in April, with strong USD aversion causing a sharp rally in the world’s most traded pair. A key question for the market is whether that gap is closed as Trump’s term progresses, if uncertainty continues to diminish, or whether dollar holdings are reduced further and the gap widens. In any case, the USD’s gains on interest rate differentials have been impacted by the latest US labour market report, where revisions to past data saw jobs undershoot expectations by an aggregate of 289,000 over the past three months. The market now has its money on a Fed rate cut in September, but we have a few more important data releases before then.
EURUSD decouples from interest rates in response to Trump’s policies
Sources: Bloomberg, Macrobond, Investec
Sterling has fallen to its lowest level versus the euro for 20 months
The Bank of England continued its rate-cutting cycle at its latest meeting, reducing its interest rate by 25 basis points (bps) to 4.00%. Our economists expect that trend to continue, until the Bank rate reaches 3.00% in 2026, continually narrowing the UK-EU rate differential. Recent weaker economic data in the UK has pushed the market’s thinking in a similar direction, and sterling has suffered as a result. GBPEUR’s slump found support at the 1.1400 big figure, as it did in November 2023. That looks to be the key level for now, which may be tested again as we approach Rachel Reeves’ Autumn Budget. The Chancellor will have to hope for favourable economic growth forecasts by the OBR when it assesses the outlook for public finances against fiscal rules, else some tough decisions on spending and taxation may be in order. A Truss-Kwarteng repeat is highly unlikely, but the market will not shy away from selling both gilts and sterling if the sustainability of UK public finances is left in doubt.
GBPEUR falls to a new cycle low
Notes: dma = day moving average
Sources: Bloomberg, Macrobond, Investec
Looking at moves elsewhere in FX...
..in the G10, the Australian dollar outperformed most of its peers and tested its 0.6600 resistance versus the USD on several occasions. The South African rand weakened as US-SA relations seemed to sour, but the ZAR has since recovered and tops the charts so far in the month of August. The Indian rupee has fallen to its lowest level versus the USD since February, not helped by Trump’s recent tariff threats on the world’s most populous country. Trump’s extended Liberation Day ‘reciprocal’ tariff deadline has passed, but trade policy will remain a focus for the time being while the details of trade deals are agreed, and more notably still, negotiations continue between the US and China. From an FX and interest rate market perspective, upcoming US data, which will determine the moment the Fed decides to pull the trigger on cuts, is eagerly anticipated, as is the President’s announcement of his nominee for the next Fed Chair at some point soon.
Forecasts
Sources: Macrobond, Bloomberg, Investec
GBP/USD
GBP/EUR
Notes: Forecasts are produced by Investec Economics and are for end-quarter
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Ria Selvaratnam
Head of Treasury Sales
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