How much further can the USD strengthen?

Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst. It's Friday 26th June 2026 and joining Lee to pose some questions on the financial market themes for the week ahead is Henry Cook, Senior Economist. This material is only intended for professional investors in jurisdictions in which its use is permitted under applicable laws, rules and regulations.

It has been produced for information purposes only and should not be construed as investment research or advice. MUFG EMEA disclaimers and disclosures can be located on our website. Hi Henry, thanks again for joining today's podcast.

This week we've seen UK political risk has been a big focus point for financial markets after the resignation of UK Prime Minister Keir Starmer. But the impact on gilts and the pounds has been relatively muted. Be interesting to hear your kind of latest thoughts on the recent developments in UK politics and how these policies could change under the new leadership.

Yeah, yeah, another UK Prime Minister. It sort of follows on doesn't it from Andy Burnham, so Starmer's key leadership rival. He won decisively in that by-election last week.

He's back in Parliament, he's got lots of momentum. I think Starmer thought the writing on the wall and he announced his resignation on Monday. It's not a huge surprise.

I think we've been talking about political uncertainty being a key risk theme for some time. When we're talking about the UK outlook, what does it mean for the outlook? Well, initially, it seems as though Burnham will not face a contest to become Labour leader.

There was a chance, of course, that we'd have a leadership contest, which you have to say that Burnham would ultimately have won it. But there would have been a period of uncertainty. There would have been a risk of market volatility if Burnham felt obliged to make spending pledges.

And it also would have meant policy drift under Starmer kind of in the meantime. But that's all been avoided. And I think we saw some signs of relief around that in markets.

But it is going to be a rapid transition. If he is uncontested, Burnham is set to become UK Prime Minister as soon as mid-July. And we're still in the dark, really, when it comes to his economic policies.

He will be constrained a bit by Labour's election manifesto, of course. But I think until we have more clarity, there will be speculation around possible changes, which will be a headwind for spending and investment in the UK. He is set to make a speech next week.

Let's see how much detail he goes into at this stage. He is the ex-mayor of Manchester. And we know he's keen on devolving powers back to local authorities.

Beyond that, he's reported to sort of favour business-friendly socialism. That's the label. And I think it's him trying to strike a balance between his kind of left-leaning instincts, which is stronger than Starmer, and market pragmatism as well.

Thanks, Henry. And I think that's definitely one of the reasons why I think we've seen a relatively muted market reaction in the gilt market and for the pound this week. Investors now are more used to the idea of Burnham becoming the next Prime Minister.

And as we've heard from him previously, he has kind of said very clearly that he would stick to the government's current fiscal rules, which limits the room for fiscal policy to be loosened significantly going forward. And at the same time, there were also reports kind of leaked at the end of last week, suggesting that Andy Burnham is speaking with some kind of well-respected economists over here in the UK, such as former Bank of England chief economist Andy Haldane. So that is as well helping to ease some of those concerns over the direction of policies going forward in the UK.

Admittedly, obviously, we need to wait and see what kind of policy changes are announced going forward. Definitely the kind of key test point would be kind of heading into that kind of autumn period when the budget is released. The other big focus I think worth highlighting as well this week is what's been happening in the FX market, where we've seen the dollar strengthened significantly against most major currencies.

If we look at the dollar index, it has broken out of the trading range that it's been in over the last 12 months. And that kind of bullish breakout has definitely kind of added to the dollar's upward momentum. In terms of kind of levels to watch out for on the upside, we'll be looking at around the kind of 103 level for the dollar index.

That's where the dollar was trading back in April of last year prior to President Trump's Liberation Day tariffs announcement. The main reason we think that the dollar has kind of regained upward momentum over the last couple of weeks is due to this divergence in expectations for monetary policy that started to open up between the Fed and other major central banks, particularly here in Europe, where we've seen the US rate market moving to price in multiple hikes from the Fed, while in Europe, we've seen yields correcting lower in response to the sharp decline that we've seen in energy prices. Certainly ourselves and I think most people in the market are probably surprised to find the price of oil all the way back to where it was pre-conflict in late February, even though the Strait of Hormuz has just started to reopen.

So the scale and the speed of the move lower in energy prices, if those energy prices are sustained at those lower levels, should mean that we get a smaller and a shorter kind of energy price shock for the global economy. And I think for European central banks, we've already started to see signs there that they would be under kind of less pressure to raise rates further from here, whereas in the US, like I said, the US rate market is happy to keep pricing in more hikes from the Fed after the hawkish policy update that we got from Kevin Walsh at his first policy meeting. And we think this is definitely kind of creating a more supportive backdrop for the dollar right now.

We think the dollar will remain strong until we see kind of a significant kind of challenge to that view that the Fed will hike rates. We need to see evidence of slowing inflation or some evidence of Fed rhetoric starting to turn less hawkish to take the upward momentum out of the dollar. So in terms of our own view for the dollar, we're still assuming that the Fed won't kind of back up this tough talk on inflation with rate hikes.

Obviously, if they don't hike rates this year, then we should see the dollar re-weaken heading into year end, alongside the fading kind of negative impact as well from the energy price shock on economies like Asia and in Europe, where they've been hit hard by the shock so far. However, if we're wrong and Chair Walsh really wants to show his kind of inflation fighting capabilities and is willing to hike rates on multiple occasions, then that could definitely open up the possibility we could see the dollar strengthening by further three to five percent through the rest of this year. So that's it in terms of our outlook for the dollar.

It'd be interesting as well, Henry, to hear your views on upcoming events to watch out for in the week ahead. Yeah, yeah. I mean, linking back to your discussion about divergence between the ECB and the Fed, it's quite a big week next week for the ECB.

There's a bit of data out. First of all, we get the first estimates of eurozone inflation in June. Lower energy costs, I think, will mean that the headline rate will go down a little bit, but the core rate is likely to remain relatively high, I think.

So that's going to keep the ECB concerned. Even under the ECB milder scenario, which is sort of conditioned on energy pricing, similar to what we're seeing at the moment in terms of the curve, even then, core inflation is seen at 2.3 percent next year. So a little bit too high for comfort.

Despite that, what I would say is over the last week or so, ECB officials have sounded a little bit more dovish since the first rate hike this month. That hike came just before the sort of decisive U.S.-Iran progress, of course, and since then, survey data like kind of output prices in the PMI and household inflation expectations, this has all pointed to a kind of reduction in risks around second round inflation effects. So yeah, let's see how Lagarde and co-frame it next week.

We've got the ECB's forum, a big week with kind of speeches from the ECB. As it stands, we continue to expect one more ECB rate hike. Market pricing is kind of converging around that mark over the last week or so.

So yeah, we're looking at a kind of measured adjustment from the ECB rather than a full-blown tightening cycle, I think. Great. Great, Henry.

Good insights for the week ahead. And yeah, thanks everyone for listening and yeah, have a good week ahead.