The US dollar rose during today’s trading session, supported by a weaker euro and renewed selling pressure in government bond markets, as investors reassessed expectations for US monetary policy. The US Dollar Index climbed to 102 points after recording its first weekly decline in five weeks, driven by lower expectations of an interest rate hike in the near term. The dollar’s gains coincided with escalating political and fiscal tensions in France, prompting investors to reduce their exposure to European assets, particularly French government bonds and the euro.
France experienced widespread protests over rising living costs and reduced spending on public services, with demonstrations turning into clashes with police and incidents of looting across several cities, increasing political pressure on President Emmanuel Macron’s government. The unrest came amid growing concerns about France’s public finances, particularly as the budget deficit reached 5.4% of GDP and the cost of insuring sovereign debt climbed to levels not seen in several years. These pressures spread to the bond market, where the yield spread between French and German government bonds widened to 147 basis points from approximately 110 basis points in late September, reaching levels last seen during the European debt crisis of 2011 and 2012.
The euro declined between 0.24% and 0.3% against the US dollar, according to the trading figures reported, as investors demanded a higher risk premium on French assets. Political developments have also become an increasing concern for markets, particularly amid discussions surrounding Marine Le Pen’s prospects in the upcoming presidential election and her position toward the European Union, raising questions about France’s future economic and political relationship with the bloc. Macquarie analysts believe that continued unrest could prompt further selling of the euro and French government bonds, while the likelihood of European Central Bank intervention could increase if financial pressures spread to the banking system and trigger deposit outflows.
US Treasury markets experienced mixed movements across the trading periods covered by the reports. The yield on 10 year Treasury bonds initially increased by 4.5 basis points to 5.145%, as selling pressure spread from French government bonds to the US market, while the 2 year Treasury yield rose to 4.776%. In another trading period, yields declined as investors returned to government bonds and oil prices moved lower, pushing the 10 year yield down to 5.079% and the 2 year yield to 4.717%. These contrasting movements reflect the influence of interest rate expectations and demand for safe haven assets on US government bond pricing.
Investors are closely watching the Federal Reserve meeting scheduled for October 27 and 28, following stronger than expected US inflation data that initially increased expectations of another interest rate hike. However, comments from Kevin Warsh subsequently moderated those expectations. One reading from the CME FedWatch tool indicated an 87% probability that the Federal Reserve would leave interest rates unchanged at its upcoming meeting, while another report showed markets pricing in a 91% probability of a rate increase in December. Meanwhile, a 2.3% decline in oil prices, following the announcement of an exemption from US sanctions related to Russian energy, helped ease inflation concerns and supported demand for government bonds.
In the eurozone, the yield on German 10 year government bonds remained stable at 3.412%, while the 2 year yield increased slightly to 3.080%, reflecting continued expectations of tighter monetary policy. European Central Bank President Christine Lagarde warned that higher borrowing costs were placing additional pressure on households and businesses while reducing consumers’ ability to absorb rising energy prices. Although tighter financial conditions could help bring inflation lower, they also increase pressure on economic activity, particularly amid ongoing geopolitical tensions and elevated energy costs. Markets were expecting the European Central Bank to raise interest rates by another 25 basis points in December, bringing the benchmark rate to 2.75%, following two increases over the previous four months.
A recovery in artificial intelligence stocks also supported the US dollar after an earlier market selloff raised concerns about the sustainability of capital inflows into US financial markets. ING analysts believe that volatility in the technology sector has become an important factor shaping monetary policy expectations, with investors increasingly viewing stock market declines as a potential reason for the Federal Reserve to scale back its plans for further interest rate increases, even while inflation remains elevated. This relationship could weaken the dollar’s appeal as a safe haven during periods of turbulence in US equity markets, particularly if declining stock prices are accompanied by lower expected returns on dollar denominated assets.
In currency markets, the Japanese yen weakened against the US dollar amid continued differences between American and Japanese monetary policy expectations, while investors remained cautious about the possibility of intervention by Japanese authorities to support the currency. Bank of Japan Governor Kazuo Ueda stated that underlying inflation was approaching the central bank’s 2% target, supported by strong demand linked to artificial intelligence and tight labor market conditions. His remarks reinforced expectations that the Bank of Japan would continue gradually normalizing monetary policy, with the possibility of additional interest rate increases later in the year.
The Canadian dollar gained against the US currency, supported by accelerating inflation and growing expectations that the Bank of Canada would maintain a restrictive monetary policy stance. The currency strengthened to trade near 1.4108 Canadian dollars per US dollar. Economic data showed that annual inflation increased to 3.1% in September from 3% in August, although the reading was slightly below market expectations of 3.2%. Energy prices were the main driver of higher inflation, rising 19% from a year earlier, while gasoline prices surged 27.8% over the same period.
Comments from Bank of Canada Governor Tiff Macklem suggested that the central bank could revise its inflation forecasts higher due to persistently elevated crude oil and petroleum product prices. However, there has been limited evidence so far that these price pressures are spreading broadly to other goods and services. This leaves the central bank balancing the risks of persistent inflation against the impact of higher borrowing costs on economic activity, while the Canadian dollar’s performance remains sensitive to energy price developments and expectations surrounding future interest rate decisions.
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