The dollar correction that began after Jackson Hole may continue as the Fed stays reluctant to hike while the ECB tightens, Bannockburn says. German elections and the Xi-Trump meeting add risk to the euro and yuan.
Alpha Score of 54 reflects moderate overall profile with weak value, strong quality, moderate sentiment. Based on 3 of 4 signals – score is capped at 90 until remaining data ingests.
The dollar correction that began after Fed Chair Warsh's hawkish Jackson Hole speech may have further to run, according to Bannockburn's September monthly outlook. The key macro transmission channel is the divergence between a Fed that remains reluctant to hike despite full employment and an ECB that keeps tightening. That gap, not any single headline from Beijing, Berlin, or Paris, will drive exchange rates through the fourth quarter, the report said.
The dollar had been dragged down by soft July data, a net loss of jobs, cooling inflation, and declining retail sales, but Warsh's comments shifted market expectations. The swaps market now prices in almost 15 basis points of a possible 25 bp hike at the mid-September FOMC meeting, and the odds of a second hike before year-end have risen from near zero to material. Momentum indicators for the dollar turned higher. Even if the market overreacted, the upside correction has only just begun, the outlook said.
September brings a cluster of events that will shape the macro narrative into year-end: a Xi-Trump meeting in Washington on Sept. 24, German state elections, a Fed decision with a new Summary of Economic Projections, and an ECB meeting that is not finished hiking. Each carries its own logic, but together they sketch the contours of the fourth quarter.
The euro rose about 0.5% in August, paring its year-to-date loss to roughly 1.4%. But technical and fundamental considerations point to downside risks. The euro's rally since late July stretched momentum indicators, and the correction that began in late August could extend toward $1.15 or a little lower after the $1.17 level held, the report said.
The political risks are palpable. German state elections this month carry real risk that the AfD wins outright in at least one Land. That would be a marker, not just a headline. Chancellor Merz has seen his personal support and that of the coalition government fall to near-record lows. Polls find a majority of Germans do not expect Merz to complete his term. The AfD challenges in the state elections could provide an extra push.
France's Macron is a lame duck, and Le Pen leads the polls. The question hanging over Paris and Frankfurt alike is whether ECB President Christine Lagarde takes a page from Mario Draghi's playbook and steps back into French domestic politics to challenge Le Pen directly. If Lagarde departs, the succession fight at the ECB becomes immediate. Germany has a case to make for the top job, but the bid is complicated by the fact that Germany already holds significant positions in Brussels. That opens space for another idea now circulating in EU corridors: an Eastern European vice president for the ECB, which has never had one.
The swaps market has a rate hike at the Sept. 10 ECB meeting almost fully discounted and nearly 75% chance of a hike in Q4. The staff updates their economic forecasts, and the risk seems to be for higher inflation next year. The market appears ill-prepared for the possibility of an AfD breakthrough, the report said.
The yen was the only G10 currency that did not appreciate in August, despite the joint US-Japan intervention in late July. The dollar finished August higher on the month, rising to JPY160.20, its highest level since the intervention. The next area to watch may be around JPY160.80, the report said. Japanese investors used the intervention-inspired bounce to buy the most foreign stocks and bonds in two years, even as speculative yen shorts in CME futures were reduced.
The Bank of Japan meets against a backdrop of disappointing Q2 growth. Consumption contracted 0.1% despite real wage gains, and capex shrank for the third quarter in the past four. National core CPI has not been above the 2% target this year. Nevertheless, the swap market now prices almost an 85% chance of a September hike, double the level at the end of July.
Beijing has facilitated the continued gradual appreciation of the yuan, which has gained nearly 4% against the dollar this year. The US 10-year premium over China widened to more than 300 bp in August, nearly a record. Ahead of the Xi-Trump meeting in late September, the yuan may consolidate, the report said. But the gradual appreciation that has been in place since April 2025 is expected to continue.
The Bannockburn World Currency Index, composed of the currencies of the dozen largest economies, edged up 0.3% in August after a 0.65% gain in July. Since around "Liberation Day" in April 2025, the index has been in a clear range between about 90 and about 92. It frayed the upper end at 92.45 in May, matching its highest level since April 2024. It trades slightly above 92 as August winds down. The risk-reward favors a dollar bounce after broadly trending lower over the past couple of months, the outlook said.
For traders tracking these dynamics, the EUR/USD profile and broader forex market analysis pages offer real-time context on the divergence that is driving the fourth-quarter macro picture.
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