The divergent monetary policy narrative has re-emerged to pressure the USD against major currencies.

The Federal Reserve’s narrative has turned decidedly dovish. Amid data lapses caused by the US government shutdown, the Fed has tilted from a data-dependent approach towards a risk-management stance. Fed Chair Jerome Powell indicated that policymakers would look past the recent uptick in inflation in favour of further rate cuts to support a potentially weakening labour market. Fed Governor Christopher Waller called for a 25-bps cut at the upcoming FOMC meeting on October 29, while Fed Governor Stephen Miran urged a more aggressive 50-bps cut. Such public advocacy for specific rate cuts – particularly by Trump-linked officials – could be viewed as another instance of political encroachment on the Fed’s independence. Having retreated from the October 10 peak of 99.6 to 98.4, the DXY Index could extend its decline toward 97.5 during the Fed’s blackout period next week. However, the path may be volatile, as markets await the rescheduled US CPI release on October 24 despite expectations of a dovish outcome at the FOMC.

In contrast, the European Central Bank signalled no urgency to adjust interest rates, stressing policy settings and the euro area economy are in “a good place.” The ECB and Brussels will also be relieved that French Prime Minister Sebastien Lecornu survived two no-confidence votes, thanks to the support of the Socialist Party in exchange for suspending President Emmanuel Macron’s 2023 pension plan. It was crucial that France, the EU’s second-largest economy and founding member, submitted its draft Budget 2026 on time. A delay could have undermined confidence and fuelled speculation about spillovers into other member nations. Barring further political shocks, markets are likely to leave French lawmakers to their difficult budget negotiations and revisit the issue for its passage at the end of the year. Hence, in the second half of October, EUR/USD could recover to 1.1780, retracing its losses from the first half of the month.

The Bank of England is likely to postpone rate cuts, mindful of the UK’s elevated inflation and the risk of the November 26 Autumn Budget reigniting fiscal jitters. We do not share the market’s concerns about a repeat of the 2022 mini-budget crisis, when the Truss government unveiled large, unfunded tax cuts while bypassing the Office of Budget Responsibility (OBR). Today’s context is different. Both the BOE and the Fed are already easing, with lower global yields providing relief to GBP/USD, which has rebounded to around 1.3450 from key support at 1.3250. It is essential that Chancellor Rachel Reeves is receptive to the IMF’s advice not to reduce the twice-yearly economic forecasts to one. The earlier IMF Article Review praised Britain’s balance between growth support and fiscal sustainability, suggesting refinements to the budgetary framework (fiscal rules) that could help minimize the frequency of policy changes. If Reeves is amenable, she could help GBP/USD push higher towards 1.35-1.36.

Having cut its policy rate to 0%, the Swiss National Bank demonstrated in September that it will rely on FX interventions – rather than a return to negative rates – to temper the CHF’s haven appeal during bouts of USD weakness. Given Trump’s high tariffs on Switzerland, policymakers appear to be keeping the CHF stable against the EUR rather than the USD. This makes sense because the Eurozone is the most significant trading partner of Switzerland. A late-September joint statement between Washington and Bern reaffirmed their commitment to avoid exchange rate manipulation. Interestingly, USD/CHF has already reversed this month’s gains, breaking below 0.7950, and eyeing the following supports at 0.79 and 0.7850.

The Bank of Japan is keeping the door open to a winter hike. BOJ Board Member Naoki Tamura cited the JPY’s weakness as an inflation risk warranting a rate hike at the October 29-30 meeting. BOJ Governor Kazuo Ueda repeatedly cited “significantly low” real interest rates as a justification for monetary policy normalization, with hikes preconditioned on the data meeting the central bank’s projections. Meanwhile, US Treasury Secretary Scott Bessent said that the JPY would “find its own level” if the BOJ pursued “proper monetary policy”, reaffirming the Trump administration’s discomfort with the JPY’s multi-decade weakness. USD/JPY has fallen to 150 from its 153.25 peak on October 10, after the Komeito party pulled out of the ruling Liberal Democratic Party (LDP) coalition. To fully retrace its post-Takaichi rally earlier this month, USD/JPY will be watching the Diet vote on October 24 to elect Japan’s next prime minister. If Sanae Takaichi fails to convince the Japan Innovation Party (Inshin) to form a new coalition with the LDP, the opposition parties could unite behind a single candidate, possibly ushering in a non-LDP prime minister in over a decade. Combined with a dovish Fed, the backdrop could keep USD/JPY falling toward 147.

Quote of the Day
“In the depth of winter, I finally learned that there was in me an invincible summer.”
     Albert Camus

October 17 in history
The Nobel Prize in Literature 1957 was awarded to Albert Camus for his important literary production, which with clear-sighted earnestness illuminates the problems of the human conscience in our times.