Dollar momentum builds as FX markets reset
Market overview
The dollar has broken higher with conviction, helped by a powerful mix of technical buying, defensive flows and renewed confidence in the US macro story. While the move looks bigger than the shift in Fed pricing alone would suggest, the broader market backdrop has turned decisively more supportive.
Rate markets have not fully matched the scale of the dollar rally. US 2-year OIS has fallen by around 7bps since Monday, while expected hikes by year-end have eased from 42bps to roughly 35bps. That makes this less of a simple rates story and more of a broader repositioning move.
The technical break has been crucial. DXY has pushed through the 100 to 100.50 area, while EUR/USD has lost the 1.14 handle, opening the door to fresh momentum buying after a long period of consolidation. Softer equity sentiment, led by pressure across technology names, has added another layer of support as investors trim exposure to the AI trade and rotate back into the dollar’s defensive qualities.
USD: Breakout supported by real yield strength
The dollar’s latest leg higher has been underpinned by a stronger US fundamentals narrative. The Fed’s recent messaging, led by Warsh’s press conference, has helped restore a sense of policy credibility just as the data pulse has improved.
Real yields have continued to grind higher, supported by firmer activity indicators, while term premia have moved lower. Falling oil prices have also reduced inflation uncertainty, allowing markets to place greater confidence in the Fed’s ability to keep price pressures under control.
That combination is powerful for the dollar. Higher real yields point to a resilient US economy, while lower term premia suggest investors are demanding less compensation for holding duration risk. Together, they create a more constructive backdrop for further dollar gains.
Today’s PCE inflation report will be the immediate catalyst. Consensus looks for a rise to 4.1% in May from 3.8%, which would be the highest reading since 2023. A result in line with expectations would likely be enough to revive hawkish Fed bets and shift the market closer to pricing two hikes this year. For DXY, 101.20 is the next level to watch.
GBP: Cable exposed to US inflation risk
Sterling has weakened, but the move is largely a dollar story rather than a sterling-specific sell-off. GBP/USD has dropped towards 1.3150, its lowest level since November 2025, as the dollar rally broadens across G10.
Lower oil prices have also played a role in reshaping UK rate expectations. With Brent below $75, markets now price slightly less than one Bank of England hike by December, reducing a previous source of sterling support.
The picture is steadier against the euro. GBP/EUR finished yesterday broadly unchanged and remains around 0.5% higher on the week. With both the ECB and BoE seeing some hawkish premium fade, neither side of the cross has had a strong enough rates impulse to take control.
Political developments have done little to unsettle markets. Investors continue to look past Starmer’s resignation, helped by signs that Labour is working to deliver a smooth transition to Burnham. Support from other potential leadership figures has further reduced the risk of a disorderly handover.
For GBP/USD, the near-term path runs through US PCE. A hotter number would likely pull the pair towards 1.31.
EUR: Policy divergence weighs on the single currency
The euro has lost meaningful ground as rate differentials return to the centre of the FX debate. EUR/USD is down more than 2.5% this month and is heading for its steepest monthly decline in nearly a year.
The relative policy story has turned against the single currency. Sticky US inflation and resilient economic data have pushed markets towards a more hawkish Fed profile. By contrast, softer eurozone growth and easing price pressures have weakened the case for further aggressive ECB action.
Energy is no longer offering the euro the same lift. Lower oil prices should help the eurozone by easing inflation and improving the region’s terms of trade, but those positives are being overwhelmed by the rates channel. The Germany-US 2-year spread has moved to its most dollar-supportive level since September, reinforcing the downside pressure on EUR/USD.
Options positioning also points to caution. Skew across both short- and long-dated maturities has shifted further towards euro weakness, showing that investors are increasingly hedging for a deeper move lower.
Technically, the break below 1.14 leaves EUR/USD vulnerable, with support around 1.1340 now in play. A softer US PCE print could slow the decline, especially with the move looking stretched. Still, unless a fresh euro-positive catalyst emerges, the pair looks likely to trade with a lower bias and could settle into a 1.11 to 1.15 range in early Q3.
Looking ahead
US PCE sets the tone: an in-line or stronger print should keep the dollar supported.
DXY has room to extend: 101.20 is the next upside marker if Fed hike expectations rebuild.
Cable remains fragile: GBP/USD could test 1.31 if US inflation surprises higher.
EUR/USD bias stays lower: the break below 1.14 keeps downside risks alive.
Rate spreads remain decisive: relative central bank pricing is again the main driver across G10 FX.