USD: Oil surge revives dollar demand
The US dollar is back in demand as geopolitical tensions in the Middle East flare up once again, driving a sharp rebound in oil prices and restoring some of the risk premium that had faded over recent weeks. Brent crude surged by more than 8%, briefly climbing above $80 a barrel. President Trump declared the ceasefire with Iran effectively void after renewed attacks on commercial shipping in the Persian Gulf.
The move is a reminder that markets may have become too comfortable with the de-escalation narrative. Since late March, oil had fallen roughly 40% from its wartime highs as Washington and Tehran moved toward a tentative agreement and shipping flows through the Strait of Hormuz gradually improved. That calmer backdrop encouraged investors to build sizeable bearish oil positions, leaving the market vulnerable to a sharp squeeze when tensions resurfaced.
For fixed income, the implications are clear. Higher oil prices reignite inflation concerns, pushing investors to reassess the path of monetary policy, pushing bond yields back towards 2026 highs.
For FX, this is benefiting the dollar, both through the rates and the risk sentiment channel. On the former, money markets had already increased expectations that the Fed may need to tighten policy further later this year. The broader FX response remains relatively contained though. Investors appear increasingly resigned to a macro environment characterised by elevated energy prices, restrictive monetary policy and periodic geopolitical setbacks – a combination that leaves markets trapped in a higher-for-longer equilibrium rather than repeatedly repricing a new crisis.
The broader concern at this point, is not necessarily the level of oil prices, but the return of volatility. Energy markets had begun to price a relatively smooth path towards normalisation. This week’s attacks have challenged that assumption and highlighted how fragile the diplomatic process remains. If we do see a meaningful rise in volatility in oil, spilling over to other markets like rates and equities, this is likely to filter through to FX and boost demand for the US dollar.
While the latest moves could unwind quickly if negotiations regain momentum, the balance of risks has shifted. Renewed uncertainty around energy supplies, firmer inflation expectations and a modest deterioration in risk sentiment all favour the dollar near term. The next key question is whether Iran responds further, as markets may be underestimating the scope for another escalation in what remains a highly unstable situation.
EUR: Caught in a lose-lose dynamic
The euro remains under pressure, hovering near 1.14. EUR/USD remains stuck in a broader decline that has been driven by fading ECB rate expectations and an increasingly unfavourable growth outlook relative to the US.
What is notable about recent price action is that the euro is struggling even as European bond yields rise. German yields recorded their largest increase since March amid the latest Middle East flare-up and associated rise in oil prices. Under normal circumstances, higher yields might offer some support to the currency. Instead, EUR/USD has continued to weaken, highlighting the difficult position the euro currently finds itself in.
In effect, the euro is facing a lose-lose dynamic. When yields fall, the currency suffers from a dovish repricing of the ECB and diminishing rate support. Yet when yields rise, they are increasingly doing so for the wrong reasons – namely higher energy prices, tighter financial conditions and growing stagflation concerns. That is not a combination that typically attracts sustained inflows into the euro.
In short – the latest rise in oil prices has once again revived concerns over the eurozone’s terms of trade, reinforcing a theme that has persisted throughout the conflict. At the same time, the US macro backdrop remains comparatively resilient, keeping the focus firmly on rate differentials. Markets are also looking ahead to next week’s US CPI report, which could further influence Fed pricing and, by extension, EUR/USD.
Options markets are becoming more cautious too. Demand for protection against euro weakness has increased, with risk reversals shifting back in favour of the dollar. While spot markets remain relatively calm, positioning suggests investors are growing less comfortable with the near-term outlook.
For now, the balance of risks remains skewed lower, with a more forceful test of 1.14 still looking possible unless either US data soften materially or geopolitical tensions ease convincingly.
GBP: Sterling’s silent rise
Sterling continues to grind higher against the euro, having risen for an eighth consecutive day after breaking through the months-long resistance level around 1.16. GBP/EUR is currently hovering near one-year highs.
The breach was significant, triggering short covering that propelled the pair higher. To understand sterling’s resilience today, it is important to remember that, following Brexit and Liz Truss’s mini-budget, positioning towards the pound has shifted structurally bearish. In relative terms, the UK’s situation has only improved since then, prompting a gradual unwinding of those shorts that has allowed sterling to appreciate despite the absence of any obvious catalyst underpinning the move.
More recently, political drama and, more importantly, fiscal concerns are not as much at the forefront of investors’ minds. Andy Burnham has yet to be sworn in as Prime Minister, and markets are unlikely to subject his policy proposals to intense scrutiny until then. Equally, lingering geopolitical tensions in the Middle East continue to divert attention away from domestic affairs.
What adds to the upside bias are a number of less obvious factors. The UK still offers one of the highest policy rates among G10 economies, making sterling attractive from a carry perspective. In addition, there are substantial M&A-related flows. Data compiled by Goldman Sachs shows that the UK has attracted roughly $78.5 billion of inbound M&A so far in 2026, compared with an annual average of just $29 billion over the previous 15 years. These factors do not create strong bullish momentum in their own right, but they do help keep sterling supported.
Against a backdrop of latent sterling-positive forces, the clearest downside risks for sterling may be this month’s June inflation release (22 July) and the BoE policy meeting (30 July), which will include updated economic projections. Markets currently price around 35bps of tightening by year-end. Should the print undershoot/MPC acknowledge that war-related inflation risks have eased and lower its inflation forecasts accordingly, some of the current hawkish bias could be priced out, weighing on sterling.
However, much depends on whether renewed tensions around the Strait of Hormuz fade swiftly and whether Washington and Tehran once again find their way back to negotiations – a well-worn script. Even then, the second flare-up since the interim peace deal was signed is a reminder that the ceasefire rests on shaky foundations, limiting the MPC’s room to sound materially more dovish.
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Calendar: July 06-10
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
