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The EUR has a subtle advantage over the USD this week. Last week’s governing council meeting reinforced the European Central Bank’s willingness to deliver the monetary policy needed to return inflation to target. Despite two hikes in June and September, the EUR-positive case is less about the ECB’s hawkishness than its institutional credibility. Faced with resurgent oil prices, the ECB has prioritized above-target inflation over the risks to a resilient Eurozone economy. Fiscal concerns remain in France and Italy, but the ECB appears less constrained by domestic political considerations.
The contrast with the Fed is becoming hard to ignore. Fed Chairman Kevin Warsh has similarly stressed the need to restore price stability, but his rejection of forward guidance has left markets with less clarity over the Fed’s reaction function. More importantly, monetary policy is increasingly viewed in light of competing pressures from Washington. President Donald Trump wants lower rates ahead of the November midterms, while Treasury Secretary Scott Bessent is trying to contain the rise in long-dated Treasury yields. Hence, a hawkish Fed is no longer unambiguously USD-positive.
If the EUR has a credibility advantage, the JPY has a policy-regime change advantage. Speculators have unwound their short JPY positions following July’s joint US-Japan currency intervention and a shift in expectations towards further Bank of Japan tightening. Bessent also helped recast “Takaichinomics” away from being Abenomics 2.0, from reflation towards deregulation, investment, and shareholder-friendly structural reform. By implicitly pushing back against Prime Minister Sanae Takaichi’s fiscal instincts, Bessent gave the BOJ greater political room to normalize interest rates. Even former BOJ-tightening sceptics – including Takuji Aida, an economic adviser to Takaichi and a former vocal opponent of BOJ tightening – are now acknowledging the case for higher rates, strengthening expectations for a hawkish hike on September 18.
GBP looks most vulnerable of the three central banks heading into Thursday’s Bank of England meeting. The BOE is widely expected to keep the bank rate unchanged at 3.75%, leaving GBP without the policy support enjoyed by the EUR and JPY. Nevertheless, GBP could find support if the BOE narrows the gap with the ECB and the BOJ in acknowledging the renewed inflation threat posed by higher crude prices. The larger upside risk, however, comes from the Fed. With a US rate hike now heavily discounted, a Fed hold would force a potentially sharp repricing, pulling the USD lower. The market will likely take it upon itself to raise long-dated US Treasury yields to tighten financial conditions.
Quote of the Day
“The rich will do anything for the poor but get off their backs.”
Karl Marx
Today in history
Karl Marx published the first volume of Das Kapital on September 14, 1867, presenting a foundational critique of political economy and the capitalist mode of production.
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