FX Pulse quarterly update

Summary & conclusions

USD has benefitted from the war with Iran and a more hawkish Fed. However, we expect a resumption of dollar weakness as the war ends and as other central banks seem more likely to tighten. We think JPY will be the strongest major currency over the next year, followed by EUR.

Recent developments

Major central banks appear to have turned more hawkish since the closure of the Strait of Hormuz. Three of the ten central banks covered in this document raised rates during 2026 Q2 (BOJ, ECB and RBA), while the language used by others pushed market expectations of rate paths to the upside. For example, at the end of February the market implied path for ECB policy rates suggested no change in rates by the end of 2026. Since then, the ECB has raised rates by 25 basis points, and the market expects another rate hike by the end of the year (Bloomberg estimates based on overnight index swaps).

The situation is even more complex at the Fed, with Kevin Warsh taking over as Chairperson in May. After his first meeting in the chair (June), markets concluded that the FOMC had turned more hawkish. At the end of February, the market implied path of Fed policy rates suggested there would be two-to-three rate cuts by the end of 2026, whereas now the suggestion is for one-to-two rate hikes (Bloomberg calculations, based on Fed Funds futures). 

Given the change in sentiment about the Fed (and the rewidening of the 10-year spread in favour of the US dollar, as shown in Figure 4), it is no surprise that USD has made gains over the last three months. However, Figure 2 shows that those gains were limited, with CNY, GBP and AUD strengthening more. 

Explaining some of the relative currency moves over the last three months is not easy. For example, some Chinese economic indicators have been weak, while CNY has been the strongest among our group of currencies (perhaps due to strong net export performance). The contrast between AUD and CAD is interesting. If anything, we think Canada is likely to benefit more than Australia from energy disruptions, but its currency has been among the weakest. We think this could reflect concern about the non-renewal of the USMCA trade agreement.

It is also puzzling that JPY and EUR have been among the weaker currencies, considering that their three-month rates have risen more than the average and that Japanese 10-year yields have been among the strongest over three months. Further, Japanese economic data has been robust (retail sales were up 5.3% year-on-year in May, for example). Perhaps EUR and JPY have suffered from perceived vulnerabilities to the energy shock.

Sticking with JPY, Figure 3 reveals that the 3-month interest rate spread versus USD is now close to historical norms, while the 10-year spread is wider than usual (both having been unusually narrow over recent years). Nevertheless, JPY remains unusually weak, despite optimism about the economic benefits of the promised fiscal boost.

Among the currencies included in this document, the one associated with the steepest rise in 3-month and 10-year rates over the last three months is HKD. However, this reflects a normalisation after the low rates encouraged by the HKMA when the USD/HKD cross rate was approaching the lower end of its allowable range (7.75-7.85). As it is now approaching the upper end of that range (HKD weakening), Hong Kong rates are being allowed to rise.

The currency ranking was broadly similar over 12 months, with CNY and AUD at the top and JPY, NZD and CAD at the bottom. The divergence of interest rates explains some of that dispersion, with Australian 3-month and 10-year rates rising more than most, while New Zealand’s rates have been among the weakest. However, they don’t explain everything, with JPY weakening, despite Japanese rates rising more than most.

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.