FX markets steady ahead of payrolls

Market overview

FX markets briefly moved to price in a less hawkish Federal Reserve narrative yesterday, before quickly reversing course. Kevin Warsh’s appearance at Sintra disappointed those looking for a clear policy signal, with much of the discussion focused instead on the limitations of forward guidance.

US front-end yields initially fell by around 5 to 6 basis points and the dollar softened, but both moves were later retraced. The market’s eventual interpretation was that Warsh was comfortable allowing incoming data to shape rate expectations, rather than guiding investors outside formal Fed meetings.

Today’s US payrolls report is therefore the key event. Consensus sits near 115,000, with market chatter closer to 140,000, while unemployment is expected to hold at 4.3%. Unless the data delivers a clear downside surprise alongside sizeable negative revisions, the dollar should remain well supported. Another payrolls print above 100,000 could push DXY back towards the 101.50 to 101.80 area, particularly if markets lean further into the idea of an earlier Fed hike.

USD: Payrolls set to drive the next move

The dollar remains close to the middle of its recent one-week range, with investors waiting for confirmation from the labour market. The Fed can argue that, with labour force growth broadly static, even a softer jobs figure does not automatically imply a sharp rise in unemployment.

That keeps the bar relatively high for a meaningful dollar sell-off. A firm payrolls print would likely reinforce the view that US rates may need to stay higher for longer, while only a notably weak report would challenge the current dollar-supportive backdrop.

One risk worth monitoring is USD/JPY. If US data disappoints, Japanese authorities may see an opportunity to lean against yen weakness, which could create sharper intraday moves.

GBP: Sterling breaks higher as BoE pushback supports rates

Sterling outperformed as Bank of England Governor Andrew Bailey pushed back against talk of rate cuts, saying discussions on lowering UK interest rates were not currently on the table. His comments were read as relatively hawkish, helping UK yields hold up against eurozone counterparts.

That yield advantage supported GBP/EUR, which closed at its highest level in more than a year. The move also took the pair above a key resistance area, suggesting sterling may have finally broken out of the range that has contained it for much of the past year.

However, the move may not be one-way. UK political risk could return later this month or in August, particularly as attention turns to the next Labour leadership phase, potential Cabinet appointments and early fiscal policy signals. With limited room for spending without tax rises, fiscal constraints remain a key medium-term challenge for sterling.

The UK economy also tends to lose momentum in the second half of the year, and the more dovish side of the MPC may look for an opportunity to restart the easing cycle once conditions allow.

EUR: Softer inflation questions ECB resolve

The euro came under pressure after eurozone inflation undershot expectations. Headline CPI fell to 2.8% in June from 3.2% in May, below the 3.0% consensus forecast, while core inflation slipped to 2.4% from 2.6%, also softer than expected.

The data has raised fresh doubts over whether the ECB needs to deliver another rate increase in September. Markets are still pricing around 15 basis points of tightening for that meeting, but the softer inflation print has weakened the case for immediate follow-through.

That said, it may be premature to rule out another ECB move entirely. Inflation could pick up again over the coming months as several government energy support measures expire. For now, though, lower eurozone yields leave the single currency vulnerable, particularly while the Fed-dollar story remains the dominant driver.

EUR/USD may retest the 1.1300 area in the coming weeks if markets continue to price in the possibility of further Fed tightening. Further out, if the Fed ultimately stays on hold, EUR/USD could recover towards the 1.16 to 1.18 range into year-end.

Looking ahead

• US non-farm payrolls are the main event, with consensus near 115,000.

• A payrolls print above 100,000 could keep the dollar supported and lift DXY towards 101.50 to 101.80.

• A weak US labour report may raise the risk of intervention-driven volatility in USD/JPY.

• EUR/USD remains vulnerable while softer eurozone inflation weighs on ECB rate expectations.

• GBP/EUR has broken above key levels, but UK politics and weaker second-half growth could limit further sterling upside.

• EUR/GBP may extend towards 0.8545 to 0.8550, although that could mark the near-term limit of the move.