USD: Re‑escalation fears fade
Relative calm returned to markets after Monday’s eruption of violence in the Persian Gulf appeared to ease, with equities rallying and Brent crude retreating below $110 per barrel. Investors may have taken reassurance from signs that both sides are reluctant to resume hostilities, even though a resolution still appears far from achievable. President Trump said he would pause “Project Freedom” to assess whether the US could reach an agreement with Iran, citing “great progress toward a complete and final agreement with representatives of Iran.” There appears to be far less enthusiasm on the Iranian side, however, with Iran’s president dismissing US demands to resume talks as “impossible.”
In FX, the dollar opened Wednesday’s session on a softer footing, driven less by geopolitics and more by yen strength. The currency climbed to its strongest level in over two months, reaching 155.04, amid speculation that Japanese authorities may have intervened again following their efforts to support the currency on April 30.
With no explicit target level, it remains unclear how many more intervention‑driven rallies we may see. However, there are constraints: under IMF guidelines, Japan can conduct only two more rounds of three‑day interventions by November while maintaining its status as a freely floating exchange rate regime, ultimately casting doubt on the extent to which verbal intervention alone can sustain further strength in the Japanese currency. The theme therefore remains a tactical headwind for the dollar, likely to trigger episodic sell‑offs rather than sustained bearish pressure.
Turning to the data, yesterday’s releases offered little in the way of excitement. US job openings were little changed in March, while hiring rebounded, suggesting the labour market continues to show signs of stabilisation. The JOLTS release adds to an already solid March jobs report (released in April). Markets will now turn their attention to this Friday’s April report, as concerns persist over the deteriorating impact of the conflict on a cooling labour market. On a significant downside miss (65K jobs expected to have been added in April), we would expect the dollar to weaken, as the quietly hawkish bias embedded in the Fed’s outlook for the year – marked by the first instance since March of markets pricing in a chance of a rate hike by year‑end, albeit a modest 5 bps – would likely unwind. A test of the 98 line remains possible this week.
GBP: UK risk premium builds
UK bonds sold off across the curve yesterday as they caught up with moves in peer markets following Monday’s Bank Holiday closure, amid renewed tensions in the Middle East. There is more to the move, however. With UK local elections approaching on Thursday, a domestic risk premium is also contributing to higher yields, particularly at the long end, where the 30‑year yield reached its highest level since 1998.
Nonetheless, sterling managed to hold on to its daily gains, suggesting markets may have grown more tolerant of higher yields. Even in normal times, elevated gilt term premia tend to reflect increased fiscal risk relative to peers such as the US and the euro area. At the same time, markets have had time to price in a degree of political instability in the UK, effectively raising the bar for more meaningful sterling sell‑offs, despite the elevated yield environment. This tolerance is further underpinned by rising Bank of England hiking expectations, with markets now pricing in three quarter‑point rate hikes this year, up from two last week, thereby keeping sterling’s carry appeal intact. Together, these factors have cushioned sterling against immediate downside, though they may also be laying the groundwork for more pronounced bearish pressure over the medium term.
Ultimately, backlash against Keir Starmer’s leadership has been largely sidelined since the escalation of the conflict in the Middle East, masking the full implications of an increasingly hawkish Bank of England. Thursday’s election results could serve as the catalyst that brings these strands together: a significant defeat would further undermine confidence in the government’s self‑imposed fiscal rules at a time of fragile economic growth and rising conflict‑driven inflation pressures. In such a scenario, a hawkish BoE could become increasingly unfriendly for sterling, as markets may begin to interpret further tightening as exacerbating the macro backdrop, ultimately adding to strains on public finances.
That said, expectations for a worse‑case outcome appear quite entrenched, effectively widening the scope for “positive” surprises from the election result. A less‑severe outcome would likely postpone the sterling‑negative shift in market interpretation outlined above, while keeping sterling’s carry appeal intact, provided rate volatility is not reignited by a material geopolitical re‑escalation. In a scenario where political turmoil remains relatively contained following a benign outcome, we would continue to favour a mildly bullish bias on sterling.
EUR: Holding pattern around 1.17
The euro regained modest ground last week, supported by Japan’s FX intervention efforts weakening the dollar and a broadly resilient risk backdrop, despite continued volatility in energy markets. The ECB has effectively pre‑signalled a June rate hike, but that outcome is already close to fully priced, alongside expectations for two additional 25bp moves by year‑end. As a result, while some scope remains for marginal near‑term gains, particularly if Middle East tensions ease further or Japan steps up intervention, EUR/USD now trades above levels implied by rate differentials, limiting the potential for sustained upside.
So far this week, supportive cross‑asset dynamics have helped stabilise the pair. With global equities pushing to record highs, oil prices easing, and the yen strengthening again, EUR/USD has reclaimed the 1.17 handle, rebounding from its 200‑day moving average near 1.1680, which has provided reliable technical support in recent sessions. However, this recovery has done little to alter the broader risk balance.
Downside risks remain prominent. Renewed attacks in the Strait of Hormuz earlier this week have increased the probability that oil prices stay higher for longer, amplifying pressure on euro‑area growth and reviving stagflation concerns. Against this backdrop, the prospect of ECB tightening looks increasingly uncomfortable, reinforcing the view that the rate channel offers limited additional support for the euro at current levels.
If further repricing emerges, it is more likely to come from the USD side. A prolonged Middle East conflict would underpin higher energy prices, reinforce haven demand, and increase the likelihood of a more hawkish Federal Reserve narrative. Reflecting this shift, FX options markets already point to fading euro support, with demand for downside protection quietly rebuilding.
Overall, EUR/USD remains supported for now — but upside conviction continues to look fragile.
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Calendar: May 04-08
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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.
