The EU and China understanding was one of the highlights of October, but the China shock rolls on. The economic disruption from China’s export drive continues. Even as the Chinese yuan gradually appreciates, the price competitiveness of many Chinese goods appears to be increasing.
Nor is the disruption from the United States going away, and it is not just about tariffs. Businesses and investors have learned to price the tariff headlines, however imperfectly. What is harder to price is the unexpected. The diesel deal with Russia is a case in point. It cut across stated policy, surprises allies, and reminds everyone that Washington’s priorities can shift without warning. Planning is difficult when the rulebook is rewritten in real time.
AI Cracks
The AI investment ecosystem has been a significant contributor to growth in several economies; directly as in the US where AI investment has offset the decline in investment elsewhere and contributed to the wealth effect of rising equities. AI has also bolstered activity in other countries, including Japan, China, South Korea, Taiwan, and Mexico where exports of AI-related hardware have been strong.
Cracks in narrative materialized in October. The Philadelphia Stock Exchange Semiconductor Index fell a little, almost 15.5%. It is a volatile index, to be sure, and it is still up 50% this year after it rose 42% in 2025 and 19% in 2024. The South Korean equity market, where the production and export of AI hardware was a key driver, fell by a little more than 16% in October. Even with the pullback it is up nearly 36% this year and Taiwan’s Taiex, which fell a more modest 5.7% in October, is up about 56% year to date.
The credit side of the AI narrative also has been challenged. Credit-default swaps, which are an insurance against default, have risen sharply in recent weeks. Pulling back initial public offerings, and lower stock and debt prices show the strain. While it may be too early to draw hard conclusions, the sector is worth monitoring by businesses and investors.
US Dollar Resilience Tested
In October, the greenback rose to new highs for the year against the euro, Canadian dollar, Brazilian real and Mexican peso Still at the end of the month, only two G10 currencies were lower: the euro, and the Danish krone that shadows it.
Rising interest rates had supported the dollar but, contrary to the conventional narrative about rising rates and the lack of buyers for US debt, US interest rates pulled back in October, and this seemed be a headwind for the greenback. After rising for six consecutive weeks through late September, the US two-year yield fell for the past five consecutive weeks. It fell by about 30 bp in October, the largest monthly decline since August 2025. The US 10-year yield rose five consecutive weeks through early October and has fallen for the past four weeks. The yield fell 35 bp in October, the most since December 2023.
Consider that in late September, the Fed funds futures implied an effective Fed funds rate of almost 4.85% at the end of next year and at the end of October, it is a little below 4.45%, the lowest since September 10.
Politics
Europe, meanwhile, struck a trade deal with China. That is notable, but the sums involved are small. The modesty of the agreement itself is a warning. If a headline deal amounts to so little, the broader issues in the relationship, including overcapacity, market access and the diversion of Chinese exports, have not been resolved. They have been postponed. Yet, the agreement will likely serve as a template for future agreements.
Europe has more than trade to worry about. Its pressing domestic issues continue to metastasize. Spain holds a snap election on November 29. In France, student-led protests make vivid television, but they hardly conceal the difficult budget choices and the murky political outlook. Germany’s firewall to contain the AfD has cracked. The government has revised up this year’s growth forecast, which is welcome, yet Chancellor Merz’s tenure appears fragile. Better growth does not necessarily buy political stability.
The UK may be the most interesting. Prime Minister Burnham has changed the political debate. A decade after the Brexit referendum, he favors closer relations with the EU. Surveys suggest that if a referendum was held today, the “remainers” would win. Whether that is achievable is another matter, and it would take years. But the shift in what is thinkable is itself a development. For sterling and gilts, it adds a layer to a story already complicated by fiscal constraints and inflation that has proved stubborn.
Then there are the US midterm elections. Typically, the party in the White House loses seats. In all but two postwar midterms, it has. This year looks no different. The event markets favor the Democrats taking control of both houses of Congress and possibly securing a majority of governors.
Yet the policy implications are not clear. Will a Democratic Congress constrain the war on Iran? Will it check US unilateral action globally? Will it narrow the fiscal deficit? Divided government usually means gridlock, which may act more as a brake than a redirection. The president retains considerable room to act on trade and foreign policy, as the diesel deal shows. On the deficit, neither party has shown much appetite for restraint. That said, the third year of the presidential term (2027) tends to see the best S&P 500 performance of the presidential cycle.
Monetary Policy
Four G10 central banks meet in November. The Bank of England, the Reserve Bank of Australia, and Sweden’s Riksbank are likely to hike rates. Norway’s Norges Bank is probably on hold after hiking rates at its last meeting, in September. For investors, the message is that policy paths are diverging, and divergence tends to favor the currencies of the more hawkish central banks in the current environment. Australia and Norway have the highest policy rates in the G10 and have the strongest currencies this year.
Judging from the derivative markets, investors are confident that the interest rate cycle in the US, EMU, and Japan is not over. All three central banks are expected to hike in December. The tightening cycle is expected to carry into next year.
The upshot is that November offers plenty of event risk but few clean answers. The outcome that markets are leaning toward may matter less than what it turns out to mean.
Bannockburn World Currency Index
Bannockburn’s World Currency Index is composed of the currencies of the dozen largest economies–half of which are from high-income countries and half from emerging markets. It edged slightly lower in October after falling nearly 0.40% in September. It was the first back-to-back monthly decline since last September and October. We anticipate further losses in the coming weeks, which is consistent with our anticipation of new dollar gains.
Among the G10 components, the euro was the and the yen weakened. The euro fell by nearly 1.5%. The yen recovered late in the month and settled less than 0.1% Together the two account for almost a quarter of the index. The Canadian dollar rose by nearly 1.9%, and Australian dollar rose nearly 1.2%, but combined, they have an index weight of around 4.5%.
The emerging market currency members of BWCI were mixed. For different reasons, both the Mexican peso and Brazilian real fell, nearly 4.0% and 5.2%, respectively. Brazil’s election results surprised with the incumbent Lula pulling off a stunning victory in the run-off contest. Mexico was hit by unwinding of dollar-funded carry trades, a central bank that sounded a little dovish, and some glitches in the trade negotiations with the US. Together they account for a slightly less than 4.5% of the basket.
The Russian ruble’s 3.4% appreciation in October made it the strongest performer in the Bannockburn World Currency Index. The South Korean won rose 1.7% and the Chinese yuan gained almost 0.8%. With the help a resolute action by Indian officials, the Indian rupee, it rose by a little less than 1%.
U.S. Dollar: The Dollar Index rose to a new high for the year in the middle of October near 103.00. It recorded a 3-4 month low in August and September around 98.60. It climbed alongside the US two-year yield and, with a lag, slipped lower as rates pullback back. Still, the Dollar Index showed resilience late in the month. It remained firm even as the two-year yield fell by around 20 bp in the last week and a half. Federal Reserve Chair Warsh appears to have signaled a gradualist pace of monetary adjustment even though the PCE deflator rose to 3.6% in September, its highest level since May, and the economy expanded by a stronger-than-expected 3.4% annual pace in Q3 (2.2% in Q2). Despite poor confidence measures and household debt stress evident, consumption rose at a 3.8% annual pace in Q3. However, real spending was flat in September, which is the weakest reading since January. Warsh recognized that financial conditions tightened since the September rate hike, but refrained from calling them tight, and despite Q3 growth being almost twice what Fed officials think is the non-inflationary pace, he said there were little signs the economy was overheating. A December rate hike still seems like the most likely scenario, barring a new shock. We have a constructive near-term outlook for the dollar and suspect there is potential for new highs in the Dollar Index.
Euro: The euro underperformed among the G10 currencies in October. It lost about a 1.6% against the dollar to bring the year-to-date loss to almost 5.1%. The euro recorded new lows for the year against the dollar, sterling and yen. Social unrest in several European countries and heightened anxiety over the French deficit/debt position weighed on the euro. The French 10-year premium over German was around 80 bp as recently as early August. It widened to almost 130 bp in September and reached, on a closing basis, nearly 175 bp in October. It may not have peaked. Italy’s premium was also around 80 bp in mid-August. It rose to about 110 bp in September and 125 bp in October. Although tensions relaxed a little late in October following Moody’s decision not to downgrade France (and bring its rating in line with S&P and Fitch) but the underlying social and fiscal issues have not been resolved. The European Central Bank has hiked rates twice this year (June and September) and is widely expected to hike again in December. The swaps market is pricing in the likelihood of another hike in 2027. Terms of trade issues and China’s export push has seen the eurozone’s current account surplus shrink by almost 10% this year through August. The ECB’s staff projects the current account surplus to narrow from 1.7% in 2025 to 1.5% this year and next before returning to 1.7% in 2028. The broad approach that the EU used to slow the growth of China’s EV imports will likely serve as a template for other sectors in the coming months. The euro approached the halfway mark of the rally from the 2025 low (near $1.0140) to this January’s high ($1.2080). That retracement is near $1.1110. There may be psychological support around $1.10, but the next retracement is closer to $1.0880.
(As of October 30, indicative closing prices, previous in parentheses)
Spot: $1.1160 ($1.1255) Median Bloomberg One-month forecast: $1.1230 ($1.1380) One-month forward: $1.1175 ($1.1270) One-month implied vol: 5.8% (6.5%)
Japanese Yen: The US dollar spent most of October straddling the JPY158 area. The low for the month was recorded in late October near JPY156. For the first time this year, the core CPI, which excludes fresh food, edged above its 2% target. Still, the Bank of Japan was reluctant to hike rates in October after the September hike brought overnight target rate to 1.25%. The swaps market is pricing in about an 80% chance of a hike in December. Looking further out, we suspect the terminal rate will be around 2% in the second half of next year. The Japanese economy remains fragile. Annualized growth peaked in Q1 at 1.9% and moderated to 1.4% in Q2 and is expected to have slowed to 1.0% in Q3. The slowdown may persist through Q1 27. Rising yields at home and fiscal strains in France, coupled with the intervention a few months ago have encouraged Japanese investors to buy more domestic bonds and sell foreign bonds. In the 12 weeks since the end of July, Japanese investors sold foreign bonds in nine weeks for a cumulative sale of JPY1.87 trillion ($11.8 bln) compared with net purchases of JPY934 bln in the previous 12 weeks. Japan’s unresolved political tensions with China may be beginning to bite. Tokyo has asked the US to intercede on its behalf to get Beijing to allow exports to several critical metals to Japan, including yttrium, a heat-resistant metal that is critical for chips, vehicles and jet engines. It is used to coat engines and plasma-etching equipment used for the fabrication of chips. The US defense supply chain relies on components with yttrium that are made in Japan. It may come to a head late this year or early 2027.
Spot: JPY157.55 (JPY157.85) Median Bloomberg One-month forecast: JPY157.25 (JPY157.00) One-month forward: JPY157.20 (JPY157.45). One-month implied vol: 7.3% (9.1%).
British Pound: The modest tax and spend budget presented in late October failed to capture the potential of transformative government’s vision. Labour’s selection of Burnham to replace Starmer has boosted the party in the polls at the same time that the Reform Party has lost some luster amid investigations into undisclosed donations and potential foreign-funding violations. In fact, Burnham’s popularity and support for Labour has spurred talk of an early election, which the prime minister has played down. In light of the shift in US policy, European security vulnerabilities, and the under-performance of the British economy over the past decade, Burnham has re-opened the Brexit debate and has explicitly and unabashedly endorsed rejoining the EU. The UK and EU hold a summit on November 20, but Burnham recognizes the need for a proper popular mandate and does not want to get too far ahead. The Bank of England meets on November 5. The market is confident, and even before the budget, a tightening sequence will be initiated. The BOE has not raised rates since August 2023. It had cut the base rate by 150 bp starting in August 2024 through December 2025. After this hike, the swaps market is pricing in three more hikes by the end of H1 27. Sterling fell by 2.1% in September, and after making a new low for the year in mid-October, it recovered to settle about 0.80% higher in the month. However, we suspect sterling’s bounce three-cent bounce in the past two-and-a-half weeks has nearly exhausted the move and move back to the $1.3280-$1.3300 area is likely after peaking at the end October near $1.3435, which frayed the 200-day moving average.
Spot: $1.3390 ($1.3240) Median Bloomberg One-month forecast: $1.3345 ($1.3300) One-month forward: $1.3395 ($1.3245) One-month implied vol: 5.6% (6.4%)
Canadian Dollar: The loss of full-time positions in August and September seemed to dash hopes that the Bank of Canada could hike rates at the end of October and close the historically wide policy gap with the US. However, Bank of Canada Governor Macklem gave a hawkish speech in mid-October and the market responded accordingly. The swaps market adjusted and discounted around an 85% chance of a hike before it was delivered on October 28. It was the first hike since June 2023. The market has at least two more hikes priced in by the end of H1 27. Between the war in the Middle East and the trade tensions with the US, price pressures have risen and growth has slowed. The central bank forecasts a 0.7% expansion this year after nearly 2% growth in 2025. It expects CPI to pick up to 2.5% from 2.1% last year. The external sector has improved markedly this year. Through August, Canada recorded an C$8.5 bln goods trade surplus compared with a C$20 bln deficit in the first eight months of 2025. At the same time, foreign investors boosted their holdings of Canadian bonds and stocks. In the first eight months of the year, foreign investors bought C$161.6 bln of Canadian financial assets, almost six-times more than in the same year ago period. The US dollar rallied persistently against the Canadian dollar in September and in the second half of October, unwound more than 60%. It recorded the year’s high near CAD1.43 in the middle of October and fell to nearly CAD1.3950 at the end of October. The next target is around CAD1.39.
Spot: CAD1.3975 (CAD 1.4250) Median Bloomberg One-month forecast: CAD1.3985 (CAD1.4120) One-month forward: CAD1.3955 (CAD1.4230) One-month implied vol: 4.2% (4.4%)
Australian Dollar: The Australian dollar tested the $0.6900 area in early October and again in the middle of October. It recovered from the three-month lows and began re-building support near $0.7000. The double bottom projects toward $0.7100, which corresponds to a retracement objective of the losses since the September high near $0.7240. The Australian dollar rose by about 1.2% in October after falling a little more than 3% in September. That puts the Aussie up about 5.1% year-to-date and makes its the second-best performing G10 currency behind the Norwegian krone’s nearly 9.2% gain. After hiking rates four times this year, Australia’s policy rate of 4.6% is the highest among the G10. The Reserve Bank of Australia meets on November 3, and some hawkish comments have put the market on notice that the tightening cycle is not over. The futures market has around an 80% chance priced in that a hike will be delivered. Still, given the strains emerging in the Australian economy (falling house prices, rising unemployment, and the preliminary October PMI slumping below the 50 boom/bust level, the market anticipates this will likely be the last hike in the cycle.
Spot: $0.7030 ($0.6955) Median Bloomberg One-month forecast: $0.7070 ($0.7010) One-month forward: $0.7025 ($0.6950) One-month implied vol: 6.7% (8.0%)
Mexican Peso: The Mexican peso was the worst performing emerging market currency in October. It fell about 4.1% against the US dollar. It had fallen by around 6.3% in September and was the first back-to-back monthly decline since the end of 2024. It has been hit by three forces. First, it handled the unwinding yen carry trades well as traders shifted to dollar-funded positions. However, the jump in US rates and the surge in the greenback hit the peso. Second, in an attempt to distance itself being tied to Federal Reserve decisions, the central bank’s minutes appeared dovish. Third, the Trump administration is pressing Mexico hard to boost imports from the US and the trade talks have reportedly stalled. The dollar reached the almost MXN18.93 at the end of October, its highest level since August 2025. The move seems excessive, and we await some price development that suggests a high has been approached. Technically, the MXN19.00-MXN19.07 remains the risk. Mexico’s central bank meets on November 5, and we expect the overnight rate target will be held at 6.50%.
Spot: MXN18.7855 (MXN18.1635) Median Bloomberg One-month forecast: MXN18.38 (MXN17.8470) One-month forward: MXN18.8240 (MXN18.2040) One-month implied vol: 12.1 (12.1%)
Chinese Yuan: The PBOC continued to signal acceptance of a gradual appreciation of the yuan. The yuan rose by about 0.8% in October, its largest monthly advance since May. Year-to-day, the yuan has appreciated by about 5% against the dollar and a little more than 10% against the euro. Given China’s cost advantage, it still is too modest to do much about China’s surplus, which has continued to grow and cause consternation among many of its trading partners. Through September, China’s trade surplus is almost 8% larger than in the first nine months of 2025. China’s export growth has been particularly pronounced in AI-related hardware, and hence more reliant on external technology demand. Domestic demand remains subdued, and even before Q3 GDP was reported (1.2% quarter-over-quarter, and 4.5% year-over-year), Beijing announced some measures that will ostensibly support the economy, like allowing provincial governments to access previously unused borrowing quotas. Beijing’s tax break for exporters, estimated at about $300 bln a year, could be reduced or eliminated to help ease trade tensions. Separately, the PBOC announced several reform measures, including switching its policy rate to the overnight reverse repo from the nine-day reverse repo, which would bring it more in line with other major economies. Although it is more a plumbing issue, it looks to be tantamount to a modest rate cut. Lastly, the PBOC also adopted measures that are aimed at boosting the attractiveness of the onshore financial market, and Panda bond issuance this year has already exceeded last year’s total.
Spot: CNY6.6545 (CNY6.7060) Median Bloomberg One-month forecast: CNY6.6700 (CNY6.7085) One-month forward: CNY6.6900 (CNY6.7265) One-month implied vol: 2.3% (2.3%)
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