Insight FX Pulse quarterly update

Summary & conclusions

USD is benefiting from a longer than expected rise in energy prices, and from a more hawkish Fed and a sharp rise in treasury yields. However, we expect a resumption of dollar weakness against some currencies if energy prices normalise downward and as other central banks tighten. We expect NZD, JPY and EUR to be among the strongest major currencies over the next year.

Recent developments

Major central banks have again turned more hawkish in the face of rising energy costs. Five of the ten central banks covered in this document raised rates during 2026 Q3 (BOJ, ECB, Fed, RBA and RBNZ), while the language used by others pushed market expectations of rate paths to the upside. For example, though the BOE has not raised rates this year, the market implied path of its policy rate suggests there will be four hikes in the next 12 months, whereas, at the end of February, the market was anticipating two rate cuts over the following 12 months (Bloomberg estimates based on overnight index swaps).

At least the situation at the Fed appears to have been clarified. When Kevin Warsh took over as Chairperson in May, it was not clear which way the Fed would lean (ease under pressure from the White House or tighten to control inflation). After his first meeting in the Chair (June), markets concluded that the FOMC had turned more hawkish and that conviction only deepened after his Jackson Hole speech. The first rate hike came at the September meeting and now the market implied path for Fed rates suggests there will be up to four rates hikes in the next 12 months (Bloomberg estimates based on Fed Funds Futures).

Given the change in sentiment about the Fed and the widening of the 10-year spread in favour of the US dollar (to levels rarely seen in recent decades, as shown in Figure 4), it is surprising that USD has not strengthened over the last three months (see Figure 2). Perhaps that is because the 3-month spread has widened less and has in fact narrowed since July, as other central banks tightened before the Fed (Figure 3 suggests that 3-month spreads are less extreme than 10-year counterparts). 

Among tightening central banks has been the BOJ, which may explain why JPY has been the strongest currency over the last three months, along with the determination of the US and Japanese authorities to prevent the Japanese currency weakening any further (see the 12-month returns in Figure 2). Perhaps more surprising has been the ongoing strength of CNY. Surprising because of the perceived softening of the Chinese economy and the fact the PBOC is expected to ease (marginally), rather than tighten. On the other hand, the net export performance of China has been impressive, which may be adding to demand for the currency.

Among the weaker currencies over the last three months have been CHF, NZD and AUD. CHF and AUD 3-month rates have risen less than elsewhere in that time, which could explain the currency weakness (and both had enjoyed strength over recent years which took their real effective exchange rates to elevated levels – see Figure 3). Though RBNZ has started tightening, it had previously eased more aggressively than other central banks.

The currency ranking was broadly similar over 12 months, though JPY is at the bottom of the 12-month ranking, while AUD is close to the top. The divergence of interest rates explains some of the 12-month dispersion, especially the rise in 10-year yields in Australia, the UK and the US, and the muted changes in 3-month rates in Switzerland, the Eurozone and Hong Kong. However, they cannot explain the weakness of JPY, nor the strength of CNY (their respective rate movements suggest the opposite currency moves). Finally, it is interesting how little support has been offered to the currencies of Canada and the US, despite the fact they are largely energy independent.

Investment risks

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.