In understanding and anticipating exchange rate movement we often privilege interest rates and the drivers of capital flows instead of trade flows. However, a new player may have entered the game. Or perhaps, more aptly, left the game. The AI meme may have cracked. From 30k feet, the semiconductor index illustrates this. The index fell by more than 10% last week, the biggest weekly slump since the first week of April 2025 (Liberation Day?). Given the AI-related contribution to US growth, and the wealth effect through the stock market, the mark down of the chip stocks seemed to cap yields. Imagine: Last Wednesday and Thursday, the yield on the 10-year Treasury note fell from almost 5.33% to 5.03%. The two-year Treasury yield fell from 4.95% to 4.68%.
Yet, ahead of the weekend, as US rates traded higher, the dollar was lifted from its lows but still finished lower against the G10 currencies but the Japanese yen, which was practically flat. The semiconductor index finished art new lows since mid-September, and in what appears to be a fairly light economic calendar but for the flash PMI at the end of the week ahead, it may continue to influence activity. The UK and China are notable exceptions of the light economic calendar generalization. The UK reports jobs data, CPI, and retail sales ahead of the following week’s much awaited budget. From Beijing, which continues to signal the acceptance of a gradually appreciating yuan, we will get the estimate of Q3 GDP. In recent weeks, the PBOC and Beijing have taken steps to help provincial governments and provide lower interest rates for targeted projects. Lastly, the other 800-pound gorilla in the room is the price of oil. December WTI jumped almost 9% last week, its third consecutive weekly gain. It set a new contract high before the weekend (~$99.35). The generic futures (what a continuous contract would look like) rose more than 10% last week, the most in three months. It reached almost $101.50 before the weekend. Last month’s high was $106.75.
US
Drivers: The 30-day correlation between DXY and the US two-year yield fell to a seven-month low before the firmer than expected September CPI last week, slightly below 0.30. The correlation may turn more robust, but the data schedule is light, and Fed officials have entered the “blackout” period ahead of the FOMC meeting on October 27-28. Given the US growth, which the Atlanta Fed GDP tracker sees 3.5% annualized in Q3, and that it is a significant energy exporter, it is still seen in the best positioned to cope with the global shocks. There may be parallels between the internet bubble and dollar rally and the AI build-out. As we saw a little last week, signs that the AI trade may be cracking is also recognized as dollar negative, at least partly through the rate channel.
Data: After last week’s CPI sand PPI, the upcoming data is unlikely to significantly alter market expectations for next week’s FOMC meeting. Inflation accelerated but after the Fed’s leadership seemed to lean against the need for back-to-back rate hikes, even while recognizing that the central bank is not done, the pricing in the futures market suggests about a little more than 15% chance of a hike this month but is convinced of two hikes between now and the end of Q1 27. The market may be most reactive to the flash PMI at the end of the week, while the Philadelphia Fed’s non-manufacturing survey may pose headline risk. September, it seems widely recognized that to the extent that higher interest rates are pinching, the real estate market may be the most sensitive. Housing starts are slower than last year, but marginally. The monthly average through August this year is for a decline of 0.3%. In the first eight months of 2025, housing starts fell by an average of 1.5% a month.
Prices: The Dollar Index met the (50%) retracement of its losses since the 2025 peak, a week before President Trump’s second inauguration, last week when it approached 103.00. However, it retreated sharply in the past two sessions and slipped slightly below 101.60 ahead of the weekend. Nearby support may be around 101.40. The momentum indicators have turned down. However, we suspect that consolidation is more likely, and ahead of the Fed, ECB, and BOJ meetings in the last week of the month.
EMU
Drivers: The changes in the euro have become more correlated with changes in the US-German two-year interest rate differential than changes in the US two-year yield over the past 30 sessions (~-0.45 vs -0.22) or changes in the German two-year yield (~0.18). Over the past few weeks, the tension in the European bond market has become a new driver. Consider that as recently as late September, the 30-day correlation between changes in the euro and changes in the French premium over Germany for 10-year rates was slightly inverse and now it is near 0.60, the highest in four months. The correlation of changes in the Italian premium over Germany is around -0.60, which is also the highest since June.
Data: The preliminary October PMI is the most impactful of the data in the coming week. However, with Europe’s move to more directly confront China’s trade practices, the eurozone current account shows greater stability than one might expect given what is happening in the auto sector. Last month’s ECB staff forecasts were that the aggregate eurozone current account was 1.5% this year and next year. It is down from 1.7% in 2025 but is projected to be there again in 2028. It has averaged about 1.7% in the past five years. It is true average that for the previous five years (2015-2019) was almost 2.8%, but that is really an anomaly. It averaged a little more than 1% in the prior five years (2010-2014) and was actually a small deficit on average in the five years before that (2005-2009). Germany’s ZEW survey attracts attention. The expectations component has risen for five months through September, but at 34.7, it is still has not fully recovered from the decline in March (new energy shock from the Middle Est war). It was at 58.3 in February and 45.8 at the end of last year. The assessment of the current situation still seems dour at -47.1 in September. Yet, it was the least negative reading since May 2023. At the end of the week, the ECB’s one- and three-year inflation survey results will be reported. They are running 2.9%-3.0%, which is 0.2%-0.3% higher than at the end last year, despite the two rate hikes the ECB delivered.
Prices: In the middle of last week, the euro approached $1.1110, which we previously noted was the (50%) retracement of the euro’s rally from the early February low last year, near $1.0140. The euro recovered strongly and reached almost $1.1270 before the weekend. The 20-day moving average is near $1.1285, and the single currency has not traded above it since September 10. The momentum indicators are turning higher, but the euro could not sustain the upside momentum ahead of the weekend. The price action seems more suggestive of consolidation than a recovery at this juncture. For that, it may require a close above $1.13.
PRC
Drivers: Through the daily setting of the fix, the PBOC has signaled the desire for gradual appreciation of the yuan. That some still focus on “stealth intervention’ by Chinese banks seems somewhat beside the point. The signal is clear, and while we cannot “disprove” that reports of dollar buying by Chinese banks is done at the behest of the central bank, the fact of the matter is that the yuan is among the strongest currencies this year and the dollar fix has been steadily falling. The rest seems like conjecture. The huge trade surplus suggests that the appreciation has not been sufficient to curb Chinese competitiveness.
Data: China reports Q3 GDP and the details for September. The median forecast in Bloomberg’s survey is for 0.9% growth quarter-over-quarter, the same as in Q2, and putting the year-over-year rate at 4.4% (from 4.3%). It is too early to see the impact of the modest efforts of Beijing and the PBOC to support the economy. Still, the PMIs point to the likelihood of a minor increase in activity in September. However, property market, including new and used house prices and sales will underscore an unresolved drag. Without stronger guidance by the PBOC, there is no reason to expect that the banks will cut their prime lending rates.
Prices: The yuan continues to slowly grind higher. The offshore yuan reached its best level since July 2022 before the weekend. The greenback slipped below CNH6.6850. The next important psychological target is CNH6.60. If the pace of the yuan’s appreciation is sustained, the US dollar could be below CNH6.40 in a year. The median forecast in Bloomberg’s survey is for it to be at CNH6.62 in the middle of next October.
Japan
Drivers: The dollar-yen exchange rate has become more correlated with changes in the US two-year yield than the 10-year over the past 30 sessions (~0.45 vs. 0.35). The correlation of changes in the exchange rate and the two-year interest rate differential is near 0.45, while the correlation between the exchange rate and the 10-year interest rate differential is near 0.35.
Data: Japan’s September CPI on October 22 will draw the most attention, but the key signal for it has already been released: the Tokyo CPI. It was reported on October and showed a large rise (2.7% from 2.5% on the headline and 2.7% from 1.8% on the core). Yet, because of idiosyncratic elements owing to Tokyo’s own subsidies, the increase on the national level is likely to be slightly less. The Bank of Japan has introduced a new measure that strips out “institutional factors” and is released a couple of days after the CPI. Japan will also report September trade balance. Seasonal factors favor improvement. Indeed, there has been only one September in the past 20 years that trade balance deteriorated. By most metrics, the yen remains terribly undervalued, yet it continues to record a persistent trade deficit. In the first eight months of the year, the trade shortfall averaged about JPY347.5 bln (~$2.2 bln). In Jan-Aug 2025, Japan’s average monthly deficit was JPY351.2 bln. In the same period in 2024, the average monthly trade deficit was JPY599.3 bln. Japan reports its tertiary activity (services) index. We already know that industrial output tumbled 1.7% in August (preliminary estimate). It increased by 0.4% in July and rose a cumulative 1.0% in the three months through July compared with a 0.6% contraction in the previous three months. The week ends with the preliminary October PMI. In September, the composite PMI was at 52.3, down from 53.5 in August and the lowest since May. It was at 51.5 in October 2025.
Prices: When US rates were rising after the firm CPI reading, the greenback reached almost JPY159, its best level since last September. Japan’s finance minister offered some verbal intervention, but it seemed to be the sharp pullback in US yields that took the dollar to JPY157.55 the following day. Despite slipping below the 20-day moving average (~JPY157.95) on an intraday basis in the past two sessions, the greenback settled above it, as it has for the past month. The five-day moving average could fall below the 20-day moving average in the coming days. Since early September, the dollar has not spent much time above JPY159. Nor has the dollar spent much time below JPY157.50 in the past two weeks.
UK
Drivers: Changes in sterling are among the least correlated with changes in the US two-year yield since late Q1 (-0.27). Sterling’s 30-day correlation with changes in the UK’s two-year yield turned slightly positive for the third time since the end of Q1 but slipped back into a small inversion at the end of last week. Its inverse correlation with the Dollar Index is around -0.89, the most extreme since mid-May. Although the euro was sold last week to new lows for the year against sterling, the two currencies continue to enjoy a robust correlation (~0.90).
Data: On one hand, in the coming days, the UK reports high-frequency economic data that is among the most important in the monthly cycle: employment, prices, and retail sales. The preliminary October PMI at the end of the week is a little kicker. On the other hand, only significant downside surprises or a new shock will dissuade the market, which very confident (~88% in the swaps market) that the Bank of England will hike the base rate 25 bp when it meets in early November. The number of payrolled employees may shrink for the eighth consecutive month. Average weekly earnings growth is slowing gradually, and some measures are not rising as fast as inflation. The core rate of inflation, which excludes not only food and energy, but alcohol and tobacco too, has gradually slowed from the 3.2% year-over-year pace at the end of last year to 2.5% in April. It has been stuck at 2.6% since May but likely accelerated (2.8%?) in September. UK differs from many by reporting retail sales on a volume rather than a price basis. And despite the slowing of earnings and softness in the labor market, retail sales have held up well this year. They have posted an average monthly gain of 0.3% through August. Retail sales rose by 0.2% a month on average in the first eight months of 2025. Still, with the rise in gasoline and diesel prices, there may have been some demand destruction. Lastly, the composite PMI was 52.0 in September, which is slightly above the year’s average, though it hit a soft patch in May and June when it slipped below 50. It finished last year at 51.4. Dragged down by services, the composite PMI may have slipped a little in October.
Prices: Sterling made a new low for the year in the middle of last week by a few hundredths of a cent to approach $1.3135. It recorded an ostensibly bearish outside down day on Wednesday, but the signal was wrong. In the past two sessions, sterling rallied from about $1.3185 to a little above $1.3370 ahead of the weekend. It posted its highest settlement since September 22. The five-day moving average kissed the 20-day moving average before the weekend for the first time since early September. The momentum indicators have turned higher. Note that sterling’s recovery was so dramatic that after fraying the lower Bollinger Band in the middle of last week, it traded above the upper Bollinger Band ahead of the weekend. Recall that the Bollinger Band is two-standard deviations above/below the 20-day moving average. Sterling’s momentum faded as the weekend approached. We anticipate near-term consolidation below $1.34.
Canada
Drivers: Over the past 30-sessions, changes in the US dollar against the Canadian dollar have become less correlated with the two-year interest rate differential and more correlated with changes in the two-year US yield (~0.45 vs 0.37). However, changes in the exchange rate have become even more correlated with the US 10-year premium over Canada (~0.47). Yet, this seems to reflect the increased significance of the US 10-year yield. The 30-day correlation of changes in the US yield and the exchange rate is approached 0.50, the most robust in a year. The correlation of the exchange rate and changes in Canada’s 10-year yield is a little more than 0.15. Alberta holds a referendum on October 19. Of the 10 issues, the one that captured the attention of international investors is the one about pursuing independence. It seems unlikely to appeal to a majority, but even a close vote may disappoint because polls in Alberta suggest the issue might not be closed for long. And the investors are aware that the new government in Quebec supports a referendum of their own for secession but only after the 2028 US election.
Data: The September CPI and August retail sales are the data highlights in the coming days, and the Bank of Canada’s business survey will be released. Canada’s CPI seems relatively tame. Although the year-over-year rate was 3.0% in August, the three-month annualized rate was zero. That might exaggerate the last of pressure and the comparable for September 2025 warns of the risk of an uptick in the year-over-year rate. Still, the underlying core rates are hovering near 2%. Although Canadian consumers took July off (retail sales fell by 0.7%), the monthly average through July is 0.6%. In the first seven months of last year, retail sales fell by an average of 0.1% a month. Even though retail sales likely rebounded in August, the data would seem to give the Bank of Canada little urgency to raise rates on October 28.
Prices: The US dollar chopped between CAD1.42 and CAD1.43 this month until October 15, when it broke down convincingly and fell to about CAD1.4135 before the weekend. Previous support–CAD1.4200–may now be resistance. The momentum indicators are falling, and the five-day moving average is likely to fall below the 20-day moving average next week for the first time since mid-September, which, as it turned out, was before the greenback rallied nearly 3% in the following month. The next technical target is around CAD1.4100, though some consolidation, here too, after a breakout, is a common pattern, as if the market were deciding.
Australia
Drivers: Changes in the Australian dollar have become more correlated over the past 30 sessions with changes in the two-year interest rate differential with the US than changes in US two-year yield (~0.45 vs. ~-0.37). The correlation between the Aussie and changes in Dollar Index is also around -0.40. The correlation of exchange rate and gold has weakened. Below 0.30, it is the lowest this year. It peaked in June near 0.85.
Data: The preliminary October PMI is the only data of note in the week ahead. The central bank has lifted rates four times this year. The impact may be seen in survey/sentiment, but the unexpected weakness in the September employment report was a yellow flag. Manufacturing may be the most vulnerable. It lurched lower in September to 49.6 from 52.0 in July and August. The service PMI softened for the second consecutive month in September. It stands at 51.9. It reached a six-month high in July of 53.6. The composite PMI also fell for two months through September (to 51.3) from a six-month high in July (53.2). The futures market is pricing in about a 35% chance of another hike at the November 3 meeting, which seems rather high.
Prices: In the past week, the $0.6900-$0.7000 range the Australian dollar has traded in this month was violated in both directions, days apart. It finished the week around the middle of the range. The disappointing jobs report and the pressure in the property market encourage investors to begin suspecting central bank is on the sideline after delivering four hikes this year. The futures market has about 20 bp of tightening priced by the middle of next year, the least in a little more than a month. The risk is that the September CPI (October 28) comes in higher and RBA Governor Bullock will not signal an end of the tightening cycle when the central bank meets on November 3. Such reasoning aligns with a break higher but with the five- and 20-day moving averages still falling, it is difficult to be confident of strong price action. Continued consolidation is the default setting.
Mexico
Drivers: Changes in the dollar against the Mexican peso remains strongly inversely correlated with the JP Morgan Emerging Market Currency Index over the past 30 session (~-0.74), though it is the least in two months. Changes in the exchange rate are almost equally correlated with changes in the US two-year yield and the Dollar Index (~0.35-0.40). The exchange rate has become less sensitive to changes in Mexico’s two-year yield (~0.03), the least since late February. It peaked in April near 0.70. The peso continues to be sensitive to the overall risk environment, for which we use the S&P 500 as proxy. The correlation is near -0.50. It has been fairly steady since early September, around the least inversion since February.
Data: Mexico’s economy contracted by 0.3% in Q1 26 and bounced back smartly in Q2, growing 1.4% quarter-over-quarter. Both numbers exaggerated underlying state of the Mexican economy, which is slow growth of around 1.5% a year. Last year’s disappointing 0.6% year-over-year growth spilled over into the early part of this year. The upcoming data, August retail sales, September unemployment, and the CPI for the first half of October are unlikely to change policy makers’ nor investors’ minds about the outlook. At the end of the week, the IGAE economic indicator, which serves the function of a monthly GDP estimate, will be reported. This year, it has averaged a monthly increase of 0.26 through July, compared with a 0.10 average in the first seven months of the 2025 and 0.17 average in the same period in 2024.
Prices: The dollar extended its surge against the Mexican peso and reached slightly above MXN18.60 in the middle of last week. It consolidated in the last two sessions but there is little to say that a top is in place. The momentum indicators are still rising even if over-extended. It is well below the upper Bollinger Band, found around MXN18.7650. That area may be the initial target on a convincing break of MXN18.60. On the downside, a push below the MXN18.2150 area could signal a consolidative/corrective phase.
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