Dollar Hits Year Highs Amid Euro Weakness and French Fiscal Concerns

The US dollar is continuing its upward trend, reaching new year-to-date highs as measured by the DXY index. This surge, however, is more a reflection of the euro's weakness than the dollar's strength, given the euro's significant weighting in the index. The euro has been under pressure due to growing fiscal concerns in France and widening bond spreads in peripheral markets, which has indirectly boosted the dollar's value.

Despite last week's softer-than-expected US payrolls report, the dollar's advance has remained largely unchallenged. Markets are still comfortable with the Federal Reserve's expected decision to leave interest rates unchanged later this month before delivering another rate hike in December. Monday's ISM services survey also met expectations, providing little reason to deviate from the prevailing narrative of dollar strength.

The dollar's resilience is further supported by the relative strength of US economic growth and interest-rate expectations. While other major central banks are seeing markets scale back their tightening expectations, investors remain reluctant to do the same for the Fed. This divergence continues to underpin the dollar's yield advantage, with the rise in US yields driven more by stronger growth and a higher expected Fed terminal rate than by fiscal sustainability concerns, unlike in France.

The euro has steadied after a sharp sell-off, with EUR/USD holding above 1.12 as the liquidation in French bonds temporarily pauses. Investors are now awaiting Marine Le Pen's alternative budget proposals, searching for signs of stabilization in France's political and fiscal backdrop. However, the mood remains cautious, with markets paying a premium to protect against further euro weakness, particularly over shorter time horizons.

The British pound has been largely influenced by broader market dynamics, with little fresh news to drive its movement. The pound's high-beta and carry-friendly characteristics have been beneficial in the current environment of subdued volatility and strong risk sentiment. However, the key risk remains a potential pickup in volatility or a reassessment of fiscal risks ahead of the UK's Autumn Budget, which could undermine sterling's recent strength.