The FX fallout from the attack on Iran has been relatively limited so far, with the a little stronger and the outperforming. It seems far too early to try and fight this dollar strength, while sharply higher prices today should weigh on the . We expect the dollar to stay supported this week as investors question Fed easing
USD: US Energy Independence and Fed Repricing to Help
The FX fallout from the weekend’s attack on Iran has been relatively contained so far in that we have not, yet, seen big 1%+ moves in key FX pairs. True, one of the most popular FX positions, long , did briefly correct more than 1% in early Asia last night but has since recovered.
Yet developments this weekend seem clearly dollar positive and we identify three channels at work here. The first is US energy independence and the energy dependence of Europe and Asia. It seems too early to expect de-escalation in the Middle East and the longer oil and natural gas prices stay higher, the bigger toll it takes on the external accounts of the fossil fuel-importing currencies. Investors will remember back in March 2022 when stayed bid above $100/bl for three months and natural gas prices tripled and didn’t peak for five months. This sustained rise in energy prices wrecked the terms of trade for the likes of the euro and yen and ushered in a sustained period of dollar strength. Until investors have a stronger idea of when this conflict ends, we would expect the dollar to stay supported. Europe’s TTF has just opened 25% higher after the 10/12% higher opening for Brent crude last night.
The second channel is what this all means for Federal Reserve policy. Notably, Fed Fund futures contract sold off 3-4 ticks in Asia on the view that the Fed might not be able to twice this year. This oil shock comes at a time when the January FOMC made it clear that the central bank was losing patience with inflation. Inflation really needed to show signs of falling, the Fed said, otherwise stabilisation in the US jobs market would question whether the Fed needs to cut rates at all. Expect the FX market today to keep one eye on the short end of the US curve and whether higher energy prices will restrain Fed easing this year. Bearish flattening of the US curve is a dollar positive.
The third and related channel is that higher energy prices and questions over the Fed’s ability to cut rates will stop and potentially reverse portfolio flows into emerging markets. The virtuous circle of inflows, stronger EM currencies, local monetary easing cycles and bond and equity rallies could all reverse if energy prices stay elevated for a sustained period. A reversal of those flows would be dollar supportive too.
Economic data releases today/this week will likely take a backseat to rolling headlines from the Middle East. For reference, however, the US calendar sees February data, where most interest could be had in the prices paid component.
has already traded through resistance at 98.00. And unless there is some very early de-escalation in the Middle East, we cannot rule out DXY heading back up to 100 this month. Certainly the benign conditions which had favoured a mild dollar decline this year have currently been put on ice.
EUR: Local Positives Are Being Re-Assessed
Higher energy prices will see investors re-appraise their view of a renaissance in European industry. That said, the global economy is in a much better position than it was when energy prices spiked in March 2022 and there is now more fiscal support than there was back then.
After a relatively contained Asian session, EUR/USD is now starting to come under pressure in early Europe. Investors have been overweight the euro and European assets on the recovery story this year – a story that will naturally be challenged this week by higher energy prices. Unless there is some early de-escalation, EUR/USD can easily get pushed back to the 1.1575/1650 region, with outside risk to the 1.1575/1600 region. Investors have been right to question the safe haven status of the dollar this year, but given the nature of this shock (energy), it will be the dollar that benefits the most.
Look out for a speech from European Central Bank President Christine Lagarde at 3:00pm CET today. It looks too early for the ECB to make a clear judgement on what the weekend’s events mean for the inflation profile, but any hawkish remarks could provide some transitory support for the euro.
Elsewhere, has approached 0.90. The Swiss National Bank will not like it, but expect the focus now to switch to negative interest rates again in Switzerland. The CHF OIS market shows the 1m OIS priced at -12bp in one year’s time. That could well be priced to -25bp as buying pressure remains on the franc.
Disclaimer: This publication has been prepared by ING solely for information purposes irrespective of a particular user’s means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Read more
