USD: Yen strength eclipses oil as key FX driver
The US dollar remains under pressure despite a renewed escalation in the Middle East that has pushed Brent crude closer to the $100/bbl mark. US strikes on Iranian tankers near Kharg Island and in the Gulf of Oman have lifted oil prices and reinforced concerns around global energy supplies.
Earlier in the conflict, such developments would likely have generated stronger demand for the dollar through both safe-haven and terms of trade channels. Over the past three months, the FX response has been notably different.
Instead, the dominant driver remains the Japanese yen. Continued strength in the currency, supported this week by Treasury Secretary Bessent’s tough rhetoric and the risk of further carry-trade unwinding, has pushed USD/JPY 2% lower this week and weighed on the broader dollar complex. The yen’s influence on FX markets is currently stronger than the dollar’s relationship with oil prices or geopolitical developments.
That leaves the wider USD story unresolved. Strong payrolls, elevated energy prices and the prospect of another inflation shock should, in theory, support the greenback. Yet markets continue to price only around 15bp of Fed tightening for September, while risk sentiment has remained surprisingly resilient.
Attention is also on Friday’s US inflation data and a busy week for the Treasury market. An upside CPI surprise would increase expectations of a Fed hike next week – USD supportive. But, $119bn of Treasury issuance and the start of the Treasury’s long-end buyback programme will keep bond markets firmly in focus too. Any renewed weakness in Treasuries risks spilling over into the dollar.
EUR: EUR/USD stuck in neutral
EUR/USD continues to trade cautiously around the 1.16 mark as it awaits a fresh catalyst for more meaningful directional momentum. Friday’s US August CPI release could provide that catalyst, with markets still undecided on the Fed’s next move.
There remains a slight bias toward a rate hike, with roughly 60% priced in. A strong jobs report last week and the recent rebound in oil prices explain the tilt.
The latest escalation in the Middle East has pushed oil prices to their highest levels since late July, with Brent flirting with the $100-per-barrel mark. Yet the euro remains unfazed.
Markets have shifted from pricing an outright oil shock, which weighed on the euro during the earlier stages of the conflict, to focusing on the broader macro backdrop, with rate differentials back in the driver’s seat.
A gradual rise in energy prices is unlikely to materially undermine the euro via terms-of-trade or growth concerns. Nor is it likely to reignite meaningful safe-haven demand for the dollar. Instead, a still-hawkish ECB and firmer Eurozone macro momentum can provide a still relatively constructive backdrop for the single currency, for now.
That said, as argued previously, the market’s hawkish ECB narrative may face a test on Thursday. The bar for delivering additional hawkish surprises looks increasingly difficult to clear, and the euro may face moderate downward pressure.
For now, we expect EUR/USD to remain trapped in a broadly subdued range, with more meaningful volatility likely reserved for Friday’s CPI release.
GBP: Calm markets, rising fiscal questions
Sterling has started the week on a relatively steady footing. GBP/USD is trading in the mid-1.35s after rebounding from four-week lows last week, while GBP/EUR has recovered back into the upper 1.16s following its worst weekly performance since mid-June. However, GBP/JPY, is down more than 1.7% this week hitting a new year-to-date low as the yen story dominates with the risk of further carry trades unwinding.
For now, the dominant drivers remain external. Global borrowing costs continue to rise, global energy prices are rising again and geopolitical tensions remain elevated. Yet despite these headwinds, volatility in FX has been subdued. Indeed, three-month implied volatility in both GBP/USD and GBP/EUR sits close to the lowest levels seen in more than a decade, suggesting markets remain unusually relaxed about the risks ahead.
Perhaps that complacency will be tested as the UK’s Autumn Budget approaches. Chancellor John Healey this week reiterated the government’s commitment to fiscal discipline and restoring credibility in bond markets. However, rising gilt yields are steadily eroding the government’s fiscal headroom. The 30-year gilt yield is approaching 6%, levels last seen before the financial crisis, increasing debt servicing costs and complicating the Budget arithmetic.
For now, markets continue to give the Burnham administration the benefit of the doubt. That partly helps explain why sterling has remained relatively resilient despite mounting fiscal questions. However, the balance of risks appears increasingly skewed towards politics as the August lull gives way to a period of increased scrutiny on UK policies and the possibility of a fiscal misstep that drags sterling lower.
Market snapshot
Table: Currency trends, trading ranges & technical indicators
Key global risk events
Calendar: September 07-11
All times are in BST
Have a question? [email protected]
*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.
