The more serious exchange of fire in the Gulf and the jump in oil yesterday have seen far less of a reaction in FX than in the rates space. However, closer to $80/bl than $70/bl stands to delay any disinflation trends and increase the risk of a . Expect the to remain bid versus the low-yielders, while the might outperform
USD: Higher Energy Prices Will Fuel the Fed Hawks
Dominating global markets yesterday was the seeming breakdown in negotiations between the US and Iran and a more serious exchange of fire. That has extended overnight, with the US military striking infrastructure targets in northern Iraq – the first strike on infrastructure since early April. Brent briefly touched $80/bl and we saw some large moves at the short end of interest curves. This follows the playbook from early March. The FX reaction was more muted, where the dollar was a little stronger, but the biggest impact was a jump in volatility and the unwinding of carry trade positions in the EM high-yielders. This especially hit extended positions in the Hungarian forint – see below.
In addition, last night saw the release of the for the June meeting. Some had feared that Fed Chair Kevin Warsh’s new non-communications strategy would gut these minutes. That was not the case. Our key takeaway is that those at the meeting were presented with two scenarios – a delayed cut in rates should inflation dissipate, or a more immediate hike if inflation remains high. Both of those scenarios were seen as equally credible. The dollar and US rates did not move much on the minutes, and it will probably be next week when we get a better steer on the Fed. Here, we have the June figure next Tuesday and Kevin Warsh’s testimony to the House on Wednesday. Today at 15CET we will also hear from the New York Fed’s John Williams. He’s from the dovish end of the spectrum.
Our bias is that higher energy prices will provide fuel for the Fed hawks and keep the dollar supported on dips – particularly against the low yielders. High-yielding currencies can enjoy better insulation against the stronger dollar given the summer months and investors’ tendency to jump into carry trade positions on any sell-off. is trading around 101.00 and we favour it back to the 101.50 area.
EUR: Greenland Seems a Distraction
has held up remarkably well given the jump in oil prices yesterday. Yield spreads did narrow in favour of the euro, where euro swap rates rose around 7-8bp more than short-dated US rates on the view that the ECB is more likely to pull the trigger on another hike in September. However, we think the Fed story will be a more dominant theme and can easily see EUR/USD handing back early gains today and sending the euro back below the 1.14 level.
Could some of the EUR/USD resilience be down to President Trump mentioning Greenland again at the NATO conference? Remember that his threats back in January sparked a backlash against US asset markets from European investors. This link looks tenuous at best.
On the eurozone calendar today is the release of the ECB minutes for the 11 June meeting. We assume this will be pitched as hawkish and, combined with higher energy prices, keep expectations alive for a follow-up hike at the September meeting. That is currently priced at +22bp by money markets.
Elsewhere, sterling continues to do well. This repeats the performance at the start of the Gulf crisis in early March. Here, the front-end of the sterling money market curve adjusts more than in the eurozone and EUR/GBP goes offered. And the underperforms in a higher rate environment on the view that the Swiss National Bank will be the last of the G10 central banks to hike. This is helping to turn the long-term bear trend and 1.10 could be the next stop here if energy prices stay high.
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