Market Overview
Global foreign exchange markets experienced significant volatility last week, driven primarily by a shift in Federal Reserve communications and geopolitical developments in the Middle East. Oil prices declined sharply amid fragile de-escalation talks between Washington and Tehran, while the incoming leadership at the Federal Reserve signaled a more restrictive policy stance than previously anticipated. These developments reshaped rate expectations across major economies and triggered broad-based dollar strength, with implications rippling through currency pairs and asset classes worldwide.
United States
The greenback rallied decisively last week following the Federal Reserve’s policy announcement, which marked the beginning of a new era in central bank communications. The incoming Fed chair eschewed forward guidance in the statement and notably did not participate in updated individual projections, a departure from prior practice. However, this restraint paradoxically amplified market focus on the Summary of Economic Projections, where nine of the remaining 18 Fed officials indicated that at least one rate hike would be appropriate during 2026. This hawkish signal sparked a 13 basis point jump in the two-year US Treasury yield, marking the largest single-session rise since April 2025.
The two-year yield has emerged as the dominant driver of dollar performance over the past 30 sessions, with a correlation coefficient of approximately 0.65 to changes in the Dollar Index. This relationship underscores how interest rate expectations directly translate into currency valuation. The Dollar Index itself broke decisively higher, reaching a new high since May 2025 with the pre-weekend peak settling slightly below 101.15. This level corresponds precisely to the 38.2% retracement of the Dollar Index’s decline from its January 2025 high, which occurred just one week before President Trump’s second inauguration.
Technical analysis suggests further upside potential for the greenback. Overcoming the 101.15 resistance area targets 102.85, which represents both the 50% retracement level and coincides with the 200-day moving average. However, traders should note that the Dollar Index may have formed an ostensibly bearish shooting star candlestick in pre-weekend trading, warranting caution regarding the near-term technical outlook. Monday’s price action will prove crucial in determining whether the uptrend maintains momentum or encounters consolidation.
The inverse correlation between the Dollar Index and the S&P 500 remains significant, though it has moderated to approximately -0.45, the least extreme reading since the end of Q1 2026. This suggests that equity market weakness may provide some support for the dollar despite the Fed’s hawkish stance.
Looking ahead to economic data, most high-frequency reports in the coming days consist of surveys, primarily from regional Federal Reserve banks, with the preliminary June PMI scheduled for Tuesday. Real sector data will include May personal income and consumption figures along with their deflators, durable goods orders, and May’s goods trade deficit. The Federal Reserve meeting scheduled for July 28-29 presents a high bar for any policy change. Fed funds futures currently discount approximately 10 basis points of tightening, with the real choice appearing to be between maintaining the current stance and implementing a 25 basis point hike. The odds of a hike are estimated at around 40%. This contrasts sharply with conditions at the end of April, when a small chance of a rate cut remained priced in, and end-of-May conditions when about 1.5 basis points of tightening was reflected in the swaps market.
Eurozone
The euro experienced significant weakness last week, falling from near $1.1620 in early trading to below $1.1420 ahead of the weekend as the backup in US rates pressured the currency. The 30-day inverse correlation between euro movements and US two-year yield changes remains robust at approximately -0.85, indicating that rising US rates consistently drive euro depreciation. Additionally, the correlation between EUR/USD and changes in the German two-year yield is inverse but weaker, at around -0.52, suggesting that European rate movements have less pronounced effects on the exchange rate than US developments.
The euro has also demonstrated the strongest correlation with the S&P 500 in more than a decade, reaching approximately 0.75 earlier this month before moderating to just above 0.60. This elevated correlation reflects the narrative of European investors purchasing US equities while hedging their currency exposure. Conversely, the euro’s correlation with the Stoxx 600 remains relatively weak at approximately 0.27, further confirming that euro weakness coincides with a rotation toward US assets.
The euro did recover modestly in light North American dealings, bouncing back to slightly above $1.1480 and potentially forming a bullish hammer candlestick. However, the currency still settled below the previous week’s low, leaving the technical picture fragile. Regaining a foothold above $1.15 is essential for stabilizing the technical tone and potentially reversing the downtrend.
On the policy front, the swaps market leans slightly toward another ECB hike next month, with such action fully discounted for September and approximately an 80% chance of another rate increase before year-end. Two surveys are scheduled this week, though neither is likely to prove decisive for the July rate decision absent a major surprise. The preliminary June PMI will be closely watched; recall that the composite output index fell four times during the first five months of the year and reached 48.5 in May, the weakest reading since January 2024. The ECB’s survey on inflation expectations will also be monitored, with the one-year expectation standing at 4.0% in May and the three-year expectation at 2.9%.
May’s inflation was confirmed at 3.2% headline with 2.5% core, while the ECB’s updated forecasts project CPI to increase by 3.0% this year, 2.3% next year, and 2.0% in 2028. These projections leave room for additional rate increases, particularly given the persistence of core inflation above the 2% target.
United Kingdom
Sterling began last week above $1.35 but deteriorated significantly, falling slightly below $1.3165 ahead of the weekend to approach the low of the year recorded at the end of March near $1.3160. The currency subsequently recovered amid the wider pullback in the US dollar, trading back toward the session high near $1.3240 in late European turnover. Near-term technical potential may extend toward $1.3275, while a push above the $1.3310-15 area would improve the technical tone more substantially.
Over the past 30 and 60 days, sterling changes have shown greater correlation with the euro than with the Dollar Index, suggesting that European developments influence cable more than broad dollar dynamics. However, sterling’s correlation with the US two-year yield is weaker than the euro’s over both timeframes. Sterling remains inversely correlated with US two-year rates, with a 30-day correlation around -0.30 and a 60-day correlation near -0.40. Notably, sterling is also inversely correlated with changes in the two-year Gilt yield, indicating that rising UK interest rates paradoxically weaken the pound.
The political landscape shifted significantly last week when Andrew Burnham won a byelection and returned to UK Parliament. Political observers widely expect Burnham to become the next Prime Minister, and the political drama will unfold over the coming days and weeks. The byelection results themselves had marginal impact on markets, with the outsized nearly 9 basis point rise in the UK 10-year Gilt yield appearing to reflect the jump in oil prices, which lifted most European yields by 5-6 basis points before the weekend, combined with the deterioration in government finances reported on Friday.
The Bank of England stood pat last week at 3.75% with a 7-2 decision, and the market is nearly evenly split regarding the outcome of next month’s meeting. However, a hike is nearly fully discounted for the mid-September meeting. The only economic report of note in the coming days is the preliminary June PMI. In May, the composite PMI fell to 49.7, marking the last time it traded below the 50 boom/bust level since October 2023. This weakness in economic activity suggests limited near-term room for rate increases despite market expectations.
China
The People’s Bank of China continues to guide the yuan higher through its daily fix, and the yuan has emerged as the strongest currency in Asia year-to-date, appreciating by 3.20% to 3.40% depending on whether measuring offshore or onshore rates. A distant second is the Singapore dollar, up approximately 0.20%, indicating that a stronger yuan has not lifted other regional currencies as one might expect from a regional growth narrative. In fact, only the onshore and offshore yuan have appreciated against the greenback among Asian currencies so far this year, suggesting that PBOC guidance is the primary driver rather than broader regional strength.
The dollar’s performance against the offshore yuan exhibits a correlation of approximately 0.65 with the Dollar Index over the past 30 sessions and slightly more than 0.70 over the past 60 sessions, confirming that the yuan’s strength is largely a function of PBOC management rather than independent currency dynamics. The dollar recorded a new three-year low against the offshore yuan in the middle of last week near CNH6.7540 before the FOMC meeting. Subsequent broad greenback gains lifted the dollar to approximately CNH6.7980 ahead of the weekend, its highest level since May 22. Near-term risk may extend to around CNH6.82.
Without signals from the central bank, Chinese banks will likely maintain loan prime rates steady at 3.0% for one-year loans and 3.50% for five-year loans. The five-year government bond yield has shown little change over the past month, hovering near 1.45%. China will likely confirm a 3.7% current account surplus in Q1 2026, though the IMF projects a slightly smaller surplus this year at 3.5% versus 3.8% in 2025, while OECD estimates steady at 3.8% before increasing to 4.0% next year.
Early Saturday Beijing time, May industrial profits will be reported. Although officials have criticized excess investment, the rise in industrial profits has been largely a function of two sectors: technology and materials. Industrial profits surged 24.7% year-over-year in April after rising 15.8% in March, demonstrating significant momentum in these key sectors despite broader economic concerns.
Japan
The Bank of Japan raised its overnight target rate to 1.0% last week in a historic move that failed to prevent the yen from extending its slide to a new low since July 2024. Despite this tightening action, the currency continued to weaken, suggesting that the rate differential between Japan and other developed economies remains the dominant driver of yen direction. Given the rate hike, Japanese officials may now count on US support for intervention in ways they did not receive during April and May interventions. By measures such as the size of speculative short yen positions in CME futures, the one-way directional bias of the market, and volatility levels, conditions favor intervention more than they did at the end of April, when the market had perceived BOJ Governor Ueda’s messaging as insufficiently hawkish.
Changes in the dollar against the yen remain more sensitive to changes in US 10-year yields than to the 10-year interest rate differential. The 30-day correlation with changes in US 10-year Treasury yields stands above 0.56, easing from a new high since last September of approximately 0.65 seen earlier in the week. This correlation approached 0.10 earlier in the year, highlighting the dramatic shift in the relationship. The correlation of exchange rate changes with the 10-year interest rate differential is approximately half as much, underscoring that US Treasury yield movements drive yen weakness more than interest rate differentials.
The dollar reached JPY161.80 the day after the FOMC’s hawkish hold, its best level since approaching JPY162 in July 2024. The greenback rose by approximately 0.65% against the yen last week, marking its fifth weekly gain in six weeks. The market has arguably become more of a one-way trade now than in late April when the BOJ intervened. At the end of April, one-month implied volatility stood near 7% before intervention; it reached 8.1% before the weekend, the highest level since May 7. As of June 9, the most recent CFTC data available, non-commercial speculators in CME futures have amassed the largest net short yen position since July 2024.
The market favors another BOJ hike before year-end, though it is not fully discounted. However, given the glacial pace at which the BOJ moves, it seems unrealistic to expect this week’s data to materially impact rate expectations. The market typically shows muted reactions to PMI data, though the May composite reading of 51.1 represents the low for the year after falling for three consecutive months. Tokyo’s June CPI will be closely watched as a good indicator of the national reading. In May, the national CPI stood at 1.5% with core at 1.4%, below the 2% target for core inflation, which excludes fresh food. The target has not been exceeded this year. Tokyo’s headline CPI was 1.4% in May with core at 1.3%. Most other developed economies would welcome Japan’s inflation dynamics, as they would likely not be raising rates under such circumstances. Japan has effectively purchased lower inflation through energy subsidies.
Canada
Changes in the US dollar against the Canadian dollar show a low correlation over the past 30 and 60 sessions with changes in the US-Canada two-year interest rate differential, at 0.15-0.18. The exchange rate is more correlated with the Dollar Index at approximately 0.57 and 0.66 respectively, and with the US two-year yield at approximately 0.53 and 0.42. The exchange rate also exhibits positive correlation with changes in Canada’s two-year yield at approximately 0.41 and 0.32, indicating that the Canadian dollar tends to weaken as either US or Canadian yields rise.
The rise of the US two-year premium began widening in early May and has risen consistently alongside the greenback’s appreciation against the Canadian dollar. The US two-year premium expanded from approximately 94 basis points on May 1 to slightly more than 140 basis points at week’s end. Since the Canadian dollar’s decline began at the start of last month, it has fallen approximately 4.15% and ranks as the worst performing G10 currency. The currency remains under pressure, falling for the seventh consecutive session ahead of the weekend. The loonie fell for the third consecutive week and the sixth week in the past seven.
The greenback reached almost CAD1.418 in North American trading before the weekend, its highest level since April 2025. With last week’s gains, the US dollar met the 50% retracement objective of the decline from the multiyear high in February 2025 of approximately CAD1.48. The next retracement level at 61.8% sits slightly below CAD1.43. However, some caution is warranted, as the US dollar settled above the upper Bollinger Band for three consecutive sessions, and momentum indicators are stretched, suggesting potential consolidation or pullback.
Bank of Canada Governor Macklem has discussed the dilemma of weak growth and firm prices as keeping the central bank on the sidelines in the coming months. The market is pricing in a hike late this year. This week’s data highlights include May CPI and the establishment jobs survey (SEPH). Through April, headline CPI has risen at an annualized pace of approximately 5.4%. The core rate stood at 1.5% in April, while the underlying core rates that the central bank monitors, though Macklem has suggested they might overstate inflation, averaged 2.05% in April. The market responds more to Canada’s household survey, which is often reported alongside US jobs data on the first Friday of the following month. The US reports household and establishment surveys simultaneously, while Canada’s establishment survey is reported with a lag. In April, the household survey found a loss of almost 18,000 jobs while the establishment survey recorded a nearly 32,000 decline. In May, the household survey saw an increase of 87,800 jobs, comprising 154,000 full-time positions offset by -46,700 part-time positions.
Australia
The correlation between changes in the Australian dollar’s exchange rate and the two-year interest rate differential is more robust than observed with the Canadian dollar, at approximately 0.60 and 0.50 over the past 30 and 60 sessions respectively. Australia’s two-year premium over the US has compressed significantly from approximately 90 basis points on April 30 to almost 25 basis points in the middle of last week, the lowest level since November. This compression reflects both the rise in US rates and the relative stability of Australian rates, weighing on the currency.
The Australian dollar may represent the closest proxy for gold among G10 currencies. The rolling 30-day correlation between AUD/USD and gold prices stands at almost 0.85, while the 60-day correlation reaches approximately 0.73, the highest level since early 2024. This relationship reflects the commodity nature of the Australian economy and the inverse relationship between the US dollar and gold prices.
The Reserve Bank of Australia has raised rates three times this year and recognizes that the impact is being felt. The bar to another hike appears quite high now, with many suspecting that the short tightening cycle may be complete, following a brief easing phase. Still, in addition to the preliminary PMI, Australia will report three data points that feed into the RBA’s reaction function: CPI, employment, and household spending. Over the four months through April, Australia’s inflation rose at a 5.7% annualized pace. Given the base effect of -0.5% in May 2025, the year-over-year headline rate may surge higher from April’s 4.2% pace. Australia lost 18,600 jobs in April for the first time this year. The unemployment rate has risen from 4.1% in December to 4.5% in April, while the participation rate has remained steady at 66.7%. Household spending is expected to have stabilized after falling 1.1% in April, which followed a 1.6% jump in March. The swing appears driven by a 1.3% decline in food following +1.6% in March, transportation dropping 4.7% after +5.4% in March, and a 2.2% contraction in clothing and footwear after +0.9% in March.
The Australian dollar recorded last week’s low in Friday’s turnover near $0.6990, subsequently recovering to approximately $0.7025 by late European session. The currency fell during the past four sessions and in nine of the past 11, leaving the technical tone fragile. A move above $0.7050 would help stabilize the picture, though traders should continue monitoring a possible head and shoulders topping pattern. The estimated neckline sits at $0.7080-$0.7100. Last week’s high, slightly below $0.7090 on Monday, tested the neckline, which is not unusual in this pattern formation. The neckline held and the Australian dollar declined for the remainder of the week. Recall that $0.7000 also represents the 61.8% retracement of the Australian dollar’s rally from the March low near $0.6835.
Emerging Markets
The Mexican peso experienced significant pressure last week as the correlation between changes in the two-year US yield and the dollar/Mexican peso exchange rate reached approximately 0.79 over the past 30 sessions, the highest level in more than 20 years. This elevated correlation exceeds the 30-day correlation between the exchange rate and the Dollar Index at approximately 0.70, indicating that US rate movements have become the dominant driver of USD/MXN dynamics. Notably, the 30-day correlation between exchange rate changes and Mexico’s two-year yield is also positive at just below 0.50, suggesting that the US dollar tends to rise alongside Mexican interest rates as well.
This week presents a full calendar of important economic data and a central bank meeting on Thursday. However, the fact remains that the Mexican economy contracted by 0.6% quarter-over-quarter in Q1. After cutting the overnight rate by 425 basis points over the past two years, and most recently while headline and core CPI remained above the 2-4% target range, the central bank has signaled an extended pause. Mexico’s headline inflation slipped slightly below 4% for the first time since January in May. The core rate remains above 4%, with the reading for the first half of June to be published on Wednesday, the day before the central bank meeting.
Before the inflation report, Mexico will release retail sales and the IGAE report, which functions as a monthly GDP estimate. The day after the central bank meets, May trade figures are due. Through April, Mexico had a $3.5 billion trade surplus compared with a $313 million deficit in the first four months of 2025 and a $9.4 billion deficit in the same 2024 period. To place the trade balance in perspective, worker remittances to Mexico were $19.5 billion in the January-April period this year, nearly matching the $19.1 billion in the same 2024 period.
The dollar had been trading in a roughly MXN17.16-MXN17.25 range in the few days before the FOMC meeting. The greenback spiked to almost MXN17.4370 in response to the hawkish hold. In the past two sessions, the US dollar has held below that high and consolidated. In the larger picture, the dollar appears well supported at MXN17.12-15 and capped around MXN17.50-MXN17.54.
Global Markets
Global equity markets reflected the hawkish Fed stance and geopolitical developments last week. Asian markets experienced mixed performance as the stronger dollar and higher US yields weighed on sentiment, though technology stocks benefited from the repatriation narrative that has driven European investors toward US equities. European equity indices declined as the combination of rising yields and dollar strength pressured multinational companies with significant US revenue exposure. US equity futures pointed to a potentially challenging open, with the S&P 500’s inverse correlation with the dollar at -0.45 suggesting limited downside given the greenback’s strength.
Sovereign bond markets experienced significant repricing as US Treasury yields surged. The two-year yield’s 13 basis point jump represented the largest single-session move since April 2025 and triggered broad-based increases across the global yield curve. European government bond yields rose by 5-6 basis points before the weekend, with the UK 10-year Gilt yield rising nearly 9 basis points as investors digested both higher US rates and deteriorating government finances. Japanese Government Bond yields remained relatively stable despite the BOJ’s rate hike, reflecting the bank’s gradual approach and the persistence of deflationary psychology in Japan.
Gold prices declined last week amid the stronger dollar and higher real yields, with the commodity struggling against the headwinds of Fed hawkishness and broad dollar appreciation. Silver exhibited similar weakness, as both precious metals face headwinds from the more restrictive monetary policy environment reflected in rising US Treasury yields. The precious metals complex will likely remain under pressure as long as the dollar remains strong and real yields elevated.
Crude oil prices tumbled dramatically during the week, falling 7-9% as fragile de-escalation negotiations between Washington and Tehran reduced geopolitical risk premiums. While the allies of both sides, namely Hezbollah and Israel, continue to clash and stall broader talks, the perception of reduced escalation risk drove significant selling pressure in energy markets. West Texas Intermediate crude fell sharply from elevated levels, while Brent crude experienced similar weakness. The combination of lower oil prices and stronger dollar dynamics created a challenging environment for energy-linked currencies and equities, though the decline provided some relief to inflation expectations and central bank policy calculations. Traders should monitor the Middle East situation closely, as renewed escalation could quickly reverse the downtrend in oil prices and trigger significant repricing across multiple asset classes.
