USD: Dollar firms as Gulf risks rise
The US Dollar Index (DXY) was modestly bid yesterday as investors began taking the latest tensions between the US and Iran more seriously. President Trump has reinstated the US blockade of Iranian ships transiting the Strait of Hormuz and has proposed a 20% fee on all cargoes passing through the waterway, payable to the US. However, details of the fee proposal remain unclear. It would be difficult to implement, would likely face significant pushback, and could add to inflationary pressures. For now, we view the proposal as a clear example of escalating rhetoric and Trump’s communication style, rather than a practical policy measure.
Oil prices surged, with Brent hovering near $85 per barrel, while bonds sold off as investors repriced expectations for a tighter monetary backdrop.
Renewed Middle East tensions are likely to diminish the market impact of today’s US CPI report. In a calmer environment, a downside surprise would have prompted a sharper unwind of hawkish Fed expectations, weighing more heavily on the dollar. However, the rebound in oil prices and the increasingly uncertain geopolitical backdrop provide a counterweight to what would otherwise have been a more dovish market reaction.
Markets continue to price in around 42bps of tightening by year-end, and we do not expect much of that to be unwound, even on a softer CPI print today.
The case for dollar strength has only strengthened amid the recent escalation in geopolitical tensions, with a move back towards the 24 June’s high of 101.800 a distinct possibility this week. Investors should also keep an eye on Kevin Warsh’s first congressional testimony today and tomorrow.
EUR: Euro faces a familiar threat
The euro’s worst nightmare may be reasserting itself. Higher oil prices and broader risk-off sentiment weighed on the single currency when the conflict first erupted in late February. That pressure subsequently eased as de-escalation momentum gathered and the US and Iran worked towards, and eventually signed, an interim deal.
The latest standoff reintroduces some familiar vulnerabilities for the euro. There is a clear terms-of-trade angle, given that the eurozone is a net energy importer, as well as a broader sentiment channel. The eurozone’s economic outlook remains highly sensitive to energy prices, and rising oil prices tend to reignite growth fears, weighing on the currency.
Meanwhile, rate differentials matter more today than they did in the early days of the conflict. As EUR/USD tends to trade asymmetrically, with moves often driven more by the dollar leg than the euro leg, a hawkish Fed creates an additional headwind for the pair.
That said, it may still be too early to call a return to all-out conflict. As such, a retest of 1.1325 may be as far as the pair travels this week. Today’s US CPI overshooting may well provide the catalyst.
GBP: Keep calm and carry on
Sterling lost some ground versus the US dollar at the start of the week as the re-escalation of tensions in the Middle East pushed energy prices higher and encouraged a broader risk-off mood across financial markets. Yet, despite the pickup in geopolitical uncertainty, FX volatility has remained surprisingly subdued, reflecting a market that lacks strong conviction rather than one that is free from risks.
With equities retreating, the pound – a high-beta currency that tends to benefit when sentiment is upbeat and stock markets are rising – came under some pressure alongside other risk-sensitive assets. GBP/USD is losing its grip on the 1.34 handle, an area that coincides with a cluster of closely watched daily moving averages. Yet, stepping back, the broader picture for sterling has been constructive of late. The pound is still up around 0.8% against the US dollar month-to-date and more than 1% stronger versus the euro, trading close to one-year highs against the single currency and above all of its key daily moving averages – a technical signal that underlying bullish momentum remains intact despite overbought conditions.
A key source of support remains the UK’s yield advantage. In today’s low-volatility environment, sterling’s relatively high-yielding nature compared to many major peers continues to attract carry trade demand, with investors borrowing in lower-yielding currencies such as the Japanese yen, Swiss franc or the euro, to invest in higher-yielding alternatives.
Importantly, calm FX markets have been the foundation of one of this year’s most profitable strategies, but carry trades are vulnerable to sharp reversals. A transition from the current low-volatility regime typically becomes more likely when rates volatility rises or when a dominant macro theme drives a stronger directional move in the US dollar. For now, markets continue to price a relatively benign outlook, but any resurgence in volatility could prompt a rapid unwind of positions that have thrived on calm conditions.
Market snapshot
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Calendar: July 13-17
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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.
