The next few days will see markets adjust to major geopolitical tensions in the Middle East, whilst also trying to navigate rising trade uncertainty and underwhelming economic data. This week will also see a smorgasbord of major central bank meetings, including the FOMC, the BoJ and the BoE. Policymakers are expected to sit on their hands, especially now with the hot conflict again between Israel and Iran.
Risk‐off sentiment helped the greenback last week, via higher oil prices. That is because the US has turned from a net energy importer to self‐reliance to a net exporter. But the key question is whether this is a longer-term driver. Geopolitical themes tend to have short shelf lives for markets, and it doesn’t offset the bearish bias and other lingering dollar negatives. The traditional dollar correlations have disappeared recently with its safe haven status diminished, and it seems it’s only the short-term shock to stocks and bonds that initially helped USD.
We would expect to see active buying on dips in EUR/USD on any indication of a de-escalation, while the yen remains the most attractive hedge if tensions spiral into a broader conflict and oil prices rise further. That could lead to more upside room for the dollar, which is already oversold and sharply undervalued in the near term. Much will depend on any restraint in retaliation by Iran, whether the US gets dragged into the conflict, and in the worst-case, if the Strait of Hormuz is affected.
The Fed policy meeting takes centre stage on Wednesday. Rates will remain unchanged, despite pressure from the White House. There is growing speculation in markets that Trump could soon nominate Fed Powell’s successor. The idea is that acting as a shadow chair, he/she could then already start talking markets towards lower rates before taking up the role in May next year. Fresh dot plots will grab the headlines this week, with very little forward guidance expected from Powell. Inflation has been making decent progress towards the 2% target with a cooling in some economic data. But tariffs and a spike in energy prices could lead to a mini-CPI resurgence. That could delay the Fed’s abilities to cut rates until potentially the final meeting of the year.