Dollar Holds Firm, Euro Faces Fiscal Pressures.

  • USD Strength Holds: Despite softer DXY, the Fed remains cautious, and strong consumer balance sheets support the dollar.
  • JPY Strength Surprise: Rising JGB yields and BOJ rate hike speculation push yen higher, particularly against the euro.
  • Euro Faces Fiscal Pressures: Increased defense spending and national debt burdens create a new fiscal risk premium for the euro.
  • Italian Bonds in Focus: Concerns over Italy’s debt levels may trigger renewed bond market stress, weighing on EUR/USD.
  • GBP Under Pressure: Rising UK gilt yields make it harder for Chancellor Reeves to present a credible fiscal plan, capping GBP/USD upside.

USD: Fed Unmoved by Consumer Concerns
The DXY dollar index is slightly softer, but this weakness is primarily driven by developments in Japan rather than a broad-based decline. Japanese markets have responded positively to the lack of official resistance against rising JGB yields, increasing speculation that the Bank of Japan could hike rates again by July. The OIS market is currently pricing in a 21bp hike, bringing the policy rate to 0.75%. The yen has shown unexpected strength despite these moderate rate changes, with speculative positions favoring further yen appreciation. Short-term USD/JPY losses remain possible, particularly with Japan’s CPI data release tomorrow, but we do not anticipate a sharp move below the 150 level. Instead, we see stronger yen performance against other currencies, particularly the euro.

As for the dollar, we expect it to remain well-supported. While US short-term yields dipped slightly after the release of January FOMC minutes, the overall tone was not particularly dovish. The Fed reinforced the need for further evidence of economic progress before considering rate cuts. Additionally, Vice Chair Philip Jefferson highlighted that households across income levels are benefiting from wealth effects, suggesting consumer balance sheets remain healthy.

Today, FX markets will also digest remarks from former President Trump about a potential new trade deal with China. This led to a slight dip in USD/CNH, but we do not expect it to trigger a broader revaluation of global currencies. Barring a significant surprise in US weekly jobless claims data, we see DXY finding support just below 107.

EUR: Fiscal Risk Premium Emerging as a Key Theme
The euro is underperforming across the board, with geopolitical shifts introducing a new fiscal risk narrative. Rising US isolationism implies that Europe will need to significantly increase defense spending. The key question is how this will be funded—whether at a European supranational level or through national budgets. Italy, in particular, faces pressure, given its high debt-to-GDP ratio of nearly 140% and growing defense obligations. Our rates strategy team believes the recent narrowing of Italian-German bond spreads could reverse as investors recognize the burden on national finances.

European bond markets have already started reacting, with a bearish steepening of bond curves. The German 2-10-year Bund curve has reached 38bp, its highest level since October 2022. Rising government bond issuance could drive a new fiscal risk premium on the euro. Meanwhile, EUR/USD lacks a strong trade risk premium, with no clear signs of an imminent downturn in US consumption or an immediate Fed rate cut. We expect EUR/USD to stall around the 1.0450/70 range and possibly fall to 1.0350 if Italian government bonds come under pressure.

Today’s eurozone data calendar includes February consumer confidence, but we anticipate little market impact. Despite low unemployment and rising real wages, trade uncertainties and European security concerns are likely to keep savings rates high and consumer demand subdued.

GBP: Rising Yields Pose a Challenge for the UK
If European bond markets continue to sell off, UK Chancellor Rachel Reeves may face an even tougher fiscal outlook ahead of her March 26 budget update. She must present a credible plan to achieve a balanced budget by FY29/30, but rising gilt yields complicate this effort.

Higher yields create a higher bar for a convincing fiscal strategy. If gilt yields are still testing their January highs by the time of the budget review, the Chancellor may be forced into one of two scenarios: either deeper spending cuts or a loss of market confidence in her fiscal plan. Neither scenario bodes well for sterling, making it unlikely that GBP/USD will sustain gains above the 1.26 level in the near term.

*All rates shown are indicative of interbank rates and should only be used for indication purposes only. It is important to note that foreign exchange rates fluctuate and that rates may vary depending on the amount and the base currency that is purchased or sold. Rates are correct as of 8:00am UK time. CentralFX are not responsible for the rates shown.