- Stock indices reacted negatively to the Fed’s rate hike.
- The dollar was once again boosted by escalating geopolitical tensions.
The US dollar has benefited from the escalating geopolitical situation in the Middle East, increased demand for safe-haven assets and an improvement in the US labour market. Employment growth of 172K in May and upward revisions to March and April figures point to temporary weakness at the end of 2025. As a result, the chances of a federal funds rate hike in 2026 have risen to 76%, and the probability of two or more hikes has jumped to 32%.
Stock indices fell sharply. The Nasdaq Composite recorded its worst weekly and daily decline in over a year. Yesterday’s leaders, chipmakers’ shares, were caught up in the wave of the most extensive sell-off. The market capitalisation of the Philadelphia Stock Exchange’s semiconductor index slumped by $1 trillion.
The rout in US shares drew criticism from Donald Trump. The US President stated that strong employment figures should have led to a rally in stock indices, not the opposite. Economic growth does not mean inflation. Investors are spooked by rumours of rate hikes, yet in reality, rates need to be cut.
The slump in the Nasdaq Composite has dampened global risk appetite and boosted demand for the US dollar as a safe-haven asset. This is all the more so given that the exchange of strikes between Iran and Israel points to an escalation of the conflict in the Middle East. Brent opened the week with an upward gap, which supported the rally in the USD index. The US is a net energy exporter, so rising oil prices have a positive impact on its currency.
A strong jobs report allowed Goldman Sachs to abandon its forecast of a federal funds rate cut in December 2026 and March 2027. The timing of the anticipated monetary easing has been pushed back to June and December of next year.
Meanwhile, there is a growing conviction in the Forex market that any tightening of the ECB’s monetary policy would be a political mistake. Parallels are being drawn not only to the global economic crisis of 2008 but also to the events of 2011. In both cases, the weakness of the eurozone economy forced the central bank to cut rates after initially raising them.
If the Fed and the ECB raise borrowing costs once each in 2026, the interest rate differential will not narrow. This will provide support for the bears on EURUSD.
