September 2025 Monthly

The Federal Reserve is poised to resume its rate cutting cycle in September. Markets briefly flirted with the idea of a 50-basis point move, but sticky core inflation, a larger-than-expected jump in producer prices, and firm retail sales have settled expectations at a quarter-point cut. The Fed continues to describe policy as restrictive, so this move will not be framed as easing but as removing a touch of that restrictiveness.

Most G10 central banks and many emerging-market peers have already cut rates this year while the Fed has held back. Now, the coming rate cuts will likely narrow interest rate differentials and weigh on the dollar. Still, this is not the start of a weak-dollar story. The greenback is rich on most metrics, but what lies ahead is a dollar that is less expensive, not cheap. The Dollar Index itself peaked three years ago, in September 2022.

The nomination of Stephen Miran to complete Adrian Kugler’s term adds a dovish voice to the Board, though even before his confirmation, the futures market is discounting more than an 80% chance of a cut in September and another cut is fully discounted for this year, in line the median "dot" in the Summary of Economic Projections has long signaled. Miran has also floated a Plaza Accord–style intervention to weaken the dollar, a provocative idea in the current environment. But with the dollar trending lower and Washington’s relations strained with other high-income partners, a “Mar-a-Lago Accord” seems neither necessary nor likely.

The Legal Front: IEEPA at Risk? Fed's Independence? 

A federal appeals court concurred with finding of the Courts of International Trade ruling on August 29 that President Trump overstepped his authority under the International Emergency Economic Powers Act (IEEPA). The panel of judges opted to send the case back to the lower court to decide whether it applied to everyone impacted or just the parties in this particular case. In the meantime, the levies continue to be collected. It still seems that the case will ultimately will have to be adjudicated by the Supreme Court.  

Even as the legal fight unfolds, the administration is preparing new tariffs under different legal authority. This time the focus is not on blanket measures but on critical sectors: semiconductors, pharmaceuticals, and possibly furniture and rare earths. The message is clear—economic security is national security.

Regardless of the outcome, the case will be appealed. Similarly, Federal Reserve Governor Cook's lawsuit seeking to prevent President Trump from firing her has also begun to play out in the judiciary. The case was heard at the end of August by a US District Judge in Washington, who was nominated by former President Biden. Here, too, there is so much at stake that an appeal seems inevitable. The issue is whether they can be expedited to the Supreme Court or will the process drag out. 

China’s Involution

Rare earths remain a particular vulnerability. China has long held leverage over global supply and has demonstrated its willingness to use it. The minerals and the magnets they produce are essential in civilian and military technologies alike. The U.S., meanwhile, holds its own choke points in advanced semiconductor intellectual property, a position it has weaponized for years. Such measures may not show up immediately in the CPI, but they reinforce the trend toward politically curated supply chains.

China’s economy continues to stumble. Property woes linger despite repeated state efforts to stabilize the sector. Reports suggest Beijing is considering pressuring state-owned firms and local governments to purchase unsold homes. Still, the swaps market shows little expectation that the People’s Bank of China will ease further in the near term, whether through rate cuts or reduced reserve requirements.

The old consensus—that China suffers primarily from under-consumption—has fractured. Some analysts continue to stress consumption as a share of GDP. But China’s consumption has risen faster than in most other large economies. Instead, the argument that China suffers from over-investment has gained traction.

That case is strong. Local governments competing with each other tend to overbuild in the same sectors—steel, cement, housing, solar panels, electric vehicles, AI. Meanwhile, state-owned banks provide patient capital that rewards market share over profitability. The central government has launched a campaign against these forces, describing the excess as “involution”. If Beijing can restrain investment, consumption’s share of GDP will naturally rise.

The Yuan Question

Most economists accept that the yuan is undervalued by 10–20%. But contrary to some claims, China is not export dependent in the classic sense. Exports are large in dollar terms because China’s economy is nearly as large as America’s, but as a share of GDP, exports account for roughly 20%—lower than Germany, France, the UK, or Canada, for example.

Calls for a sharp appreciation, citing undervaluation, are countered by OECD models that suggest the euro and yen are even more undervalued relative to fair value. It is really more generalized problem of a strong dollar. When the dollar rallied in July, the yuan performed best in the world. Chinese officials consistently reject U.S. efforts to fold the yuan into Washington’s currency playbook. Americans like to recall the Plaza Agreement of 1985 as a success, but many capitals—Tokyo and Beijing included—view it quite differently. Beijing’s preference to shadow the dollar can be read as a strategy to deny Washington competitiveness through devaluation.

Still, the PBOC has introduced more flexibility in the yuan’s daily reference rate. The average daily move remains small but is now a multiple of the 0.1% shifts that prevailed earlier this year. Since May, the central bank has been steadily lowering the dollar’s fix, bringing it to its weakest since last November. Yet volatility tells a different story: the three-month implied vol has slipped to around 3.7%, a little less than half its level in seen in April.

As the quarter winds down, the main themes are the trajectory of Fed policy, Washington testing the limits of executive authority, Beijing wrestling with structural excess, and the dollar slowly bleeding some of its strength. None of these stories are new, but their convergence adds to the sense of flux. Monetary policy, trade law, industrial strategy, and currency management—once treated as separate policy domains—are increasingly fused. Markets may prefer clarity, but what they are getting instead is the overlapping messiness of politics, economics, and law.

Bannockburn World Currency Index

Bannockburn's World Currency Index, a GDP-weighted basket of the currencies representing the 12 largest economies, rose by almost 0.70% in August. It recouped about half of what is lost in July, the first declining month of the year. Yet rather than trend in August, the BWCI moved broadly sideways after advancing in the first part of the month. We suspect the consolidation is favorable for the index and anticipate it to extend its recovery in the coming weeks. 

The six currencies among the high-income members all appreciated in August. The euro was the strongest, rising 1.2% against the dollar. The Japanese yen rose almost 1%, helped, we think, by the decline in US rates. Sterling, though rose a little more than 1%. The Canadian dollar, which as is often the case, did relatively better in July's firmer US dollar environment, losing the least (1.8%) against the greenback among the G10 currencies. In August, its 0.6% gain put it at the bottom of the high-income component currencies. 

Among the emerging market currencies, two of six currencies weakened against the dollar, the Indian rupee (-0.70%) and the Russian ruble (-0.1%). The Brazilian real was the strongest overall with a nearly 2.7% gain. The Chinese yuan edged out the Mexican peso for second place among the emerging market components, with almost a 0.70% (vs. 0.5%). These three currencies recorded new highs for the year in August.  

U.S. Dollar:  The Federal Reserve will likely do three things at this month's meeting. It will cut rates for the first time this year as the risk assessment was changed by the deterioration of the labor market. The FOMC will update the Summary of Economic Projections. In June's iteration, the median forecast was that three cuts in 2026 would be appropriate. We suspect it may be adjusted to four cuts. Lastly, with the use of the reverse repo facility falling, reserves are approaching a level that will likely prompt the Fed to slow the unwinding of its balance sheet (QT) or announce plans to end it. The Fed's balance sheet has been reduced by more than a quarter since the April 2022 peak. We expect another soft employment report on September 5, and it will be followed on September 9 by what is expected to be a sharp downward adjustment in the annual benchmark revisions to the nonfarm payroll series. We also expect higher inflation readings in the coming months as more of the tariff increases are passed on to the American consumer. Businesses and consumers should be prepared for sectoral tariffs on pharma and semi-conductor chips, even if the precise timing is not clear. The Trump administration launched an investigation into furniture trade and, and a decision seems likely before the end of the year. A new front in the White House attempt to drive monetary policy opened with claims against Federal Reserve Governor Cook. Many market participants see an attempt to encroach the central bank's independence. Still, the market has exaggerated the divestment from the United States. The Treasury's International Capital report shows foreign investors purchased a net of almost $768 bln of US financial assets in H1 25, which is more than in the first half of the last two years put together. Legal challenges to the Trump's use of emergency powers to levy tariffs will likely persist and the appellate process by eventually reach the Supreme Court. 

Euro: The euro recovered from a slight dip below $1.16 on August 1 to rise almost $1.1715 before consolidating in the last week of the month. The driver was the pullback in the dollar more broadly and the decline in US rates. The US two-year premium over Germany narrowed from 200 bp to a little below 170 bp, the least since March. With the European Central Bank's deposit rate at 2.0%, the swaps market is no longer confident of another rate cut this year (slightly more than 35% chance is discounted), though is still pricing a strong probability one more rate cut next year (about 75% chance). Despite the infrastructure and defense initiatives, eurozone growth is stuck in a low gear (0.1% in Q2 and projections are for the same this quarter). Headline inflation is likely to hover near but mostly below the 2% target in the coming months. Tensions within the eurozone are subdued. Germany's 10-year premium over Italy, Spain, and Portugal are around the narrowest since 2010. Greece's 10-year yield is trading below the comparable French yield. France has emerged as a weak link and the current government may lose a confidence vote on the same fiscal issues that toppled the previous government. It is slated for September 8. President Macron may appoint a new prime minister rather than call snap parliamentary elections.  Up against term limits, a call for a general election, would be tantamount to Macron's resignation. The EU has opted for a low-key approach to US tariffs and appears to have chosen to bide its time and secure stability rather than antagonize Washington.  

(As of August 29, indicative closing prices, previous in parentheses)  

Spot: $1.1686 ($1.1587) Median Bloomberg One-month forecast: $1.1700 ($1.1648) One-month forward: $1.1708 ($1.1611) One-month implied vol: 7.3% (7.7%)  

Japanese Yen: The exchange rate continues to be sensitive to changes in US rates. The rolling 30-day correlation of changes in the US two-year yield and the dollar-yen rate is around 0.80, near the highest since mid-2023. The correlation with the changes in the 10-year US  yield is a little below 0.80, which it has not been above since late 2021. Growth in H1 25 surprised on the upside, with Q1's annualized contraction of 0.2% revised to 0.6% growth, and Q2 GDP grew by 1%, more than twice what the median economic forecast in Bloomberg's survey projected. Japan's CPI peaked this year peaked at 4% in January and stands at 3.1%. The core rate recorded the year's high in May (3.7%) and was at 3.1% in July. Both the headline and core rates are expected to have eased further in August. The swaps market has less than a 10% chance of a rate hike in September and slightly more than 50% of a hike in October. The market is pricing a terminal rate of 1% from the current policy rate of 0.50%. We expect the dollar to trend lower in the coming weeks and target the JPY145.00-40 area. 

Spot: JPY147.05 (JPY147.40) Median Bloomberg One-month forecast: JPY145.00 (JPY143.65) One-month forward: JPY146.60 (JPY146.90). One-month implied vol: 9.4% (9.4%)  

British Pound: After falling in July (3.8%), the first monthly decline since January, sterling rebounded by about 2.0% in August. It recovered from nearly a four-month low, near $1.3140 on August 1 to finish the month a little below $1.3500. In addition to the broadly heavier dollar, sterling was aided by a reassessment of the trajectory of Bank of England policy. The implied year-end rate rose from about 3.65% in early August to almost 3.90% late-month dealings. Headline CPI reached 3.8% in July, the highest since January 2024, and Q2 growth surprised on the upside, with a 0.3% quarter-over-quarter expansion, flattered by stronger government consumption and investment. The Bank of England and private sector economists anticipated 0.1% growth. The UK two-year premium over the US widened to near 35 bp in late August, the most since last November. The UK offered a 10 bp discount in late July. The UK's 10-year premium more than doubled in August to around 50 bp, the most since April. The fiscal clouds loom on the horizon, and the key event is the Autumn budget statement, expected in early Q4. We expect sterling to challenge the multi-year high recorded on July 1 near $1.3800. Above there, potential may extend toward $1.40 before the end of the year. 

Spot: $1.3504 ($1.3279) Median Bloomberg One-month forecast: $1.3600 ($1.3454) One-month forward: $1.3510 ($1.3285) One-month implied vol: 6.9% (7.3%)  

 

Canadian Dollar: The broad pattern holds. When the US dollar is bid, as it was in July, the Canadian dollar does well against most of the other G10 currencies. In fact, in July, its 1.8% loss was the smallest decline posted by the G10 currencies. When the greenback trends lower, as it did in H1 25, the Canadian dollar does poorly. In the first six months of the year, the Canadian dollar rose 5.7% against the US dollar, the least among the major currencies. In August, the greenback fell and only the New Zealand dollar, following the central bank's dovish cut, underperformed the Canadian dollar. The Bank of Canada meets on September 17, and a rate cut did not seem particularly likely until the poor Q2 GDP report. The economy contracted by 1.6% in Q2 at an annualized rate, slightly more than twice what economists expected. And Q1 growth was shaved to 2.0% from 2.2%. The swaps market has a little more than a 55% chance discounted up from about a 1-in-4 chance at the start of August. The swaps market has about a 40% chance of a last cut in the cycle discounted, though we suspect that the weakening of the US economy, which will prompt more aggressive easing by the Federal Reserve may give the Bank of Canada more scope to ease. The US dollar was turned back from a three-month high (near CAD1.3925 on August 22) and there may be scope toward CAD1.3640-CAD1.3700 in the coming weeks. 

Spot: CAD1.3741 (CAD 1.3786) Median Bloomberg One-month forecast: CAD1.3700 (CAD1.3739) One-month forward: CAD1.3725 (CAD1.3765) One-month implied vol: 4.7% (5.0%)   

 

Australian Dollar: The Reserve Bank of Australia cut its target rate for the third time this year in August, and it now stands at 3.60%. The central bank signaled scope for continued gradual easing of monetary policy, and the market suspects that "gradual" does not mean back-to-back meetings. Still, with three meetings left in the year, the futures market has about 30-35 bp of cuts discounted. The terminal rate is seen near 3% next year. Since January 2005, the US and Australia have had a free-trade agreement that covered non-agricultural goods but excluded textiles and clothing. Although the agreement did not prevent the US from levying 10% on all Australian exports to the US (and exposure to sectoral tariffs), it did deter new "reciprocal tariffs." We continue to be skeptical that the Trump administration will support the AUKUS nuclear submarine agreement. Economic nationalism in Washington and reports of capacity constraints in the US (and UK) warn of the risk of delays or outright backtracking. The Pentagon's review is being led by Under Secretary of Defense for Policy Elbridge Colby, who has stated in the past that submarines are scarce, and that the U.S. is not able to produce enough to meet its own demand. The Australian dollar set the high for the year in late July near $0.6625. We expect that to be challenged in the coming weeks and see potential toward $0.6700 by the end of the quarter. 

Spot: $0.6540 ($0.6474) Median Bloomberg One-month forecast: $0.6500 ($0.6488) One-month forward: $0.6545 ($0.6490)   One-month implied vol: 8.1% (9.0%)  

 

Mexican Peso: For the past two months, the dollar has chopped between roughly MXN18.50 and MXN19.00. The broad consolidation follows a drop of more than 12% since the early April high. Given the scope for US rate cuts and the attractive carry Mexico offers, with relatively modest volatility, favors an eventual downside break. The MXN18.35-MXN18.40 area looks reasonable. The central bank will likely continue to ease monetary policy in quarter-point steps, and its next meeting is September 25. When it meets it will have August CPI in hand, and the inflation reading for the first half of September. Banxico estimates that the neutral real rate is between 1.8% and 3.6%. Adjusting the 7.75% overnight target rate by the 3.5% July headline inflation implies a real rate of 4.25%. The resumption of the Fed's easing cycle will also give Banxico more room to maneuver. News that Moody's has put Pemex on review for a possible upgrade following greater government support, has supported the credit. At the end of July, the US granted Mexico a 90-day tariff-extension after imposing a 17% anti-dumping tariff on tomatoes. The US immigration policy and environment are weighing on worker remittances that are worth nearly $65 bln in 2024 (compared with a $18.5 bln trade deficit). In Q2 25, worker remittances were about 12% lower than Q2 24. 

Spot: MXN18.8500 (MXN18.8595) Median Bloomberg One-month forecast: MXN18.8500 (MXN18.9359) One-month forward: MXN18.7230 (MXN18.9227) One-month implied vol: 8.8% (8.5%) 

 

Chinese Yuan:  The Chinese yuan rose by about 1% against the dollar in August to bring the year-to-date gain to almost 2.4%. It fell by 2.75% in 2024. The PBOC guides the market and manages the exchange rate primarily through setting the dollar's reference rate. It has been setting the dollar's reference rate lower on a trend basis. It has been set at its lowest level since last November. The PBOC has also introduced greater flexibility into setting the reference rate. The average daily fix changed in the last several months is a multiple of what it had been in the first part of the year. Yet, the implied (in option prices) and the historical (actual) volatility have fallen. The three-month historic volatility is below 1.8%, the lowest in a year, while the three-month implied volatility is slightly less than twice as much but is also near the lowest since July 2024. In a weak US dollar environment, the yuan is likely to be a laggard, but as was the case in July, a stronger dollar could see the yuan outperform. New policy announcements are unlikely now, ahead of the 4th Plenum, which traditionally focuses on ideological issues and state governance. Efforts to secure help from state-owned businesses to support the beleaguered property market and to extend the "anti-involution" (over-investment) campaign may be forthcoming. 

Spot: CNY7.1307 (CNY7.1933) Median Bloomberg One-month forecast: CNY7.1650 (CNY7.1861) One-month forward: CNY7.0865 (CNY7.1450) One-month implied vol: 4.9% (5.1%)

 

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