The USD is facing a difficult week despite expectations of a hawkish pause at the October 27-28 FOMC meeting. The DXY Index has retreated from its October high of 103 to around 101.5-102. Markets are increasingly questioning whether higher US interest rates can sustain USD strength, as growth concerns, stretched equity valuations, and political risks challenge the US exceptionalism narrative. 

Despite oil prices reaching 6–7-month highs, US Treasury yields have eased amid selling pressure in technology stocks. Higher energy costs may reinforce the case for further Fed tightening to contain inflation but also threaten consumption, corporate margins, and economic growth. Earnings from major AI hyperscalers will test whether they can generate sufficient revenue to sustain the scale of investment. Against this backdrop, markets will be sensitive to downside surprises in October 27’s consumer confidence index, and October 29’s PCE inflation and advance GDP estimate.

Political uncertainty adds another headwind for the USD. Prediction markets increasingly favour a Democratic sweep in the November 3 US midterm elections. While a divided government could restrain future deficit spending and debt expansion, investors must also weigh the risks of prolonged fiscal gridlock and political uncertainty. 

EUR faces an equally challenging week as the European Central Bank confronts a difficult trade-off between elevated inflation and France’s fiscal turmoil at its October 29 meeting. Although the ECB is expected to leave the deposit facility rate unchanged at 2.50%, while keeping a December hike on the table, attention is likely to focus on the 10Y OAT-Bund spread, which has widened to 170 bps, its highest level since November 2011. Markets will assess whether the ECB views the EUR’s sell-off as a justified repricing of French fiscal risks or an emerging threat to monetary policy transmission. 

However, the EUR’s outlook is further complicated by the diverging prospects across its major crosses. 

EUR/USD consolidated in a 1.1180-1.1270 range after rebounding from a 1.5-year low of 1.1113 on October 14. The currency pair faces two competing sets of risks this week. First, the Fed and ECB are expected to hold rates while retaining the option of tightening in December. Second, France’s fiscal turmoil will compete with US midterms for investors’ attention. With neither currency having a decisive monetary policy advantage, relative fiscal and political risks may become important in determining EUR/USD’s next move. 

EUR/GBP may have found support following a four-week decline from 0.8612 to 0.8362. The cross has priced in considerable optimism over the UK’s fiscal outlook relative to France’s deteriorating sovereign risk profile. GBP has also benefited from positive UK growth surprises and a 102% market-implied probability of a 25-bps rate hike to 4% at the November 5 Bank of England meeting. However, GBP still faces a credibility test from the October 28 Autumn Budget, when Chancellor John Healey must demonstrate fiscal discipline without undermining growth or repeating the mistakes of the 2022 mini-budget crisis. A fiscally responsible but growth-negative Budget, or a letdown in borrowing projections, could trigger profit-taking and prevent GBP/USD from overcoming last week’s resistance around 1.34. 

EUR/JPY has fallen to a one-year low of 176 from its end-July peak of 187.40, reflecting a shift in the balance of G3 risks. The joint US-Japan intervention on July 30, which involved the US Treasury selling EUR to buy JPY, has helped to turn the tide against JPY weakness. The Bank of Japan’s September rate hike and continued policy normalisation bias subsequently cushioned JPY against expectations of further tightening by the Fed and the ECB. Although the BOJ is expected to maintain its policy rate at 1.75% at its October 29-30 meeting, its accompanying updated outlook will likely favour stronger growth and inflation forecasts, paving the way for another hike in December.

Meanwhile, concerns over the Takaichi government’s reflationary fiscal agenda have been overshadowed by higher long-dated US Treasury borrowing costs and the repricing of France’s sovereign risks. USD/JPY has also broken below a two-week range of 157.5-159 to around 157, suggesting that the JPY is regaining some of its traditional haven appeal amid rising global risk aversion. 

Overall, the broader message is that higher interest rates are no longer a sustainable source of currency strength. Markets are increasingly distinguishing between tightening driven by economic resilience and tightening forced by inflation or fiscal vulnerabilities. 

This leaves the USD exposed to doubts over US exceptionalism, the EUR vulnerable to France’s fiscal turmoil, and the JPY better positioned to benefit from defensive positioning. Unless this week’s central bank meetings and economic releases restore confidence in growth. The balance of risks favours continued volatility in EUR/USD with an upside bias, a potential EUR/GBP rebound, and further downside in EUR/JPY. 

Quote of the Day
“Don't watch the clock; do what it does. Keep going.”
     Sam Levenson

Today in history
On October 26, 1918, Cecil Chubb deeded the prehistoric monument Stonehenge to the British people as a gift.