Wall Street closes at a record for the first time since end of January
There has been no improvement in the Middle East crisis over the weekend. President Trump’s attempt to build a naval coalition to re-open the Strait of Hormuz looks like an admission that this war will not reach a swift conclusion. Away from the Middle East, the focus will be on how central bankers respond to this energy shock. We expect the dollar to stay bid
USD: Little Improvement
The weekend brought little respite to the war in the Middle East. US and Israeli militaries continue to pound strategic targets in Iran, while Iran continues its strategy of spreading economic chaos in the region and keeping the Strait of Hormuz effectively closed. The latest initiative from Washington is to try to assemble a naval coalition to escort convoys through the Straits. The Financial Times suggests that China, France, Japan, South Korea and the UK have been asked. It is unclear whether any would accept. This news failed to impress the energy market, where Brent remains near its highs and could go higher the longer Middle-East oil supply remains shut-in. It looks like the market wants to hear news on a path to a ceasefire before removing the risk premium buoying energy and the dollar.
But until there is some news of a negotiated settlement, the market this week will be focusing on the central bank response. Eight of the G10 central banks meet to set monetary policy this week. Of those, the closest to hiking will probably be the Reserve Bank of Australia, where a 25bp hike is about 70% priced. However, our Asian team thinks it may be too early for another hike, meaning that AUD/USD faces some downside risk in Asia tomorrow.
Regarding this week’s FOMC meeting, we think the event risk is dollar positive. At the January FOMC meeting, the takeaway was that the Federal Reserve wanted to see clear signs of lower inflation before delivering further rate cuts. Events in the Middle East warn that US inflation will be heading to 3.5% and not 2.0% this summer. The FOMC will likely further question market pricing of another Fed rate cut this year, where around 23bp is still priced in by year-end. And the Fed’s dot plot could also shift the median expectation of one cut this year back into 2027 as well.
DXY is now at the top of the nine-month trading range at 100.35/40. A calmer equity environment this Monday morning suggests DXY may not be ready to break higher just yet. But investors will want to see clear evidence of improvement in the conflict before trying to pick a top in the dollar.
EUR: On Support
The latest positioning data from the CFTC in Chicago shows that investors continue to pare back euro net long positions. Yet looking at the asset manager community, positioning remains heavily net long euro and there are more adjustments to be made should conditions dictate.
Thursday’s European Central Bank meeting could also prove mildly hawkish. But the difference to the Fed is that the market already prices close to 50bp of ECB rate hikes this year. In turn, the bar is high for the ECB to move short-dated euro interest rates and the euro higher.
EUR/USD has found support at last summer’s low near 1.1390/1400. Some consolidation may be due after a quick 3% drop over the last fortnight. We do think that EUR/USD will start to move higher over coming months once oil supplies start to flow again. But that still seems a distant prospect today and another leg higher in energy could see EUR/USD still extend to the 1.12/13 area given the overhang of net euro long positioning.
CHF: SNB Might Have to Get Creative
The Swiss National Bank meets on Thursday. The strong Swiss franc will be a major concern, and the central bank will probably describe it as ’highly valued’ and confirm that it is increasingly minded to intervene in FX markets. The SNB could also try to lower interest rates through an adjustment in its remuneration of CHF sight deposits. Last September, the SNB cut the exemption on the 25bp charge on excess sight deposits to 16.5 versus 18 times minimum required reserves.
We would see upside risk to EUR/CHF around the Thursday event risk. But unless the situation alters substantially in the Gulf, it looks like the SNB will be drawn into a long campaign to support EUR/CHF below 0.90.
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