The dollar index is trading near 96.8 and down about 0.4% on the week despite a 10-year Treasury yield above 5%, as markets price a roughly 70% chance of a 25-basis-point ECB hike in September. EUR/USD is holding above 1.1000 and GBP/USD above 1.2700, with Friday's U.S. PPI print the next test of whether the dollar's weakness persists or corrects.
The dollar index traded near 96.8 on Thursday, down about 0.4% on the week, even as the 10-year Treasury yield held above 5% — a divergence that has left the greenback unable to convert higher U.S. rates into gains with the European Central Bank expected to raise borrowing costs at its September meeting.
"The dollar is being asked to carry a rate advantage it no longer owns outright," said James Okafor, a rates strategist covering the Fed and Treasury market. "When the ECB is tightening into a soft U.S. data run, the carry trade stops paying and the market takes the dollar down regardless of where the 10-year sits."
The euro has been the main beneficiary. EUR/USD held above 1.1000 through the week, with the pair's 50-day moving average near 1.0920 acting as the first line of support and the 200-day near 1.0780 beneath it. Sterling has tracked the move, with GBP/USD holding above 1.2700 and its own 50-day average around 1.2640. Both pairs have now spent three consecutive weeks above those levels, the longest stretch since the spring.
The ECB's policy rate sits at 3.25% after the central bank cut by 25 basis points in June, and Governing Council members have spent the summer warning that services inflation near 3.5% keeps the 2% target out of reach. Money markets price roughly a 70% probability of a 25-basis-point increase at the September meeting, which would be the first hike since the tightening cycle that ended in 2023. That repricing is the engine behind euro strength: a higher ECB terminal rate narrows the two-year rate differential with the U.S. and removes the yield cushion that had supported the dollar through the first half of the year.
The last time the ECB raised rates while the Fed stood still was in 2023, when the deposit rate went from 3.5% to 4% between June and September. EUR/USD rose about 4% over that stretch before giving back most of the gain by October as U.S. yields caught up. The current setup differs in one respect: U.S. yields are already elevated, which means the dollar has less room to rally on a hot inflation print.
Friday's U.S. producer price index is the near-term swing factor. Consensus looks for headline PPI at 0.3% month over month, with core — which strips food and energy — at 0.2%. The prior month's headline reading came in at 0.4%, hotter than expected, and the year-over-year headline rate has been running near 3.7%, well above the Fed's 2% target on the PCE measure.
A core PPI print at 0.4% or above would push real yields higher and give the dollar its first genuine argument for a rebound since August. A print at 0.1% or below would confirm that pipeline inflation is cooling and leave the DXY exposed to a test of the 96.0 level, with 95.2 the next reference point from the July consolidation range. The dollar index has not closed below 96.0 since early June.
The positioning backdrop makes the asymmetry sharper. The DXY's failure to respond to a 10-year yield above 5% is unusual — through 2024 and 2025, a move of that size in the 10-year typically accompanied a dollar index gain of 1% to 2% over the following month. Speculative accounts have been net short the dollar for six straight weeks, and the gap between the yield signal and the price signal suggests those shorts are not yet being squeezed. That leaves room for a sharp corrective move if PPI surprises to the upside, because a crowded short with no cushion tends to unwind faster than it was built.
The transmission runs beyond FX. A stronger dollar on a hot PPI would pressure dollar-denominated commodity prices and weigh on emerging-market currencies, while a weaker dollar would support gold and extend the euro's run. Rate-sensitive equities sit in the middle: the S&P 500 has been trading within 2% of its August record close, and a renewed push higher in long-end yields would compete directly with equity valuations.
The Federal Open Market Committee meets Sept. 15 and 16, six days after the ECB decision. Futures markets currently assign a roughly 50% probability to a Fed hike at that meeting, with a second hike by the December meeting priced at about 60%. If the ECB moves first and the Fed holds, the rate differential narrows further and the dollar's path of least resistance stays lower. If both tighten, the dollar's weakness becomes a question of degree rather than direction.
For traders, the levels that matter are straightforward. EUR/USD holding 1.0920 keeps the bullish structure intact and opens 1.1150; a daily close below it would put 1.0780 in play. GBP/USD needs to defend 1.2640 to preserve its uptrend, with 1.2900 the next resistance. The DXY's 96.0 handle is the pivot — a break below it confirms the divergence trade, while a reclaim of 97.5 would signal that the dollar has finally started pricing the yield curve it is being handed.
This article is for informational purposes only and does not constitute investment advice.
