has jumped, but still isn’t fully pricing in a fully-fledged new supply shock, meaning short-term risks remain on the upside for the dollar. So far, the rate differential is keeping afloat thanks to hawkish repricing of ECB expectations alongside the Fed’s, but further energy price increases should overcome rates as a primary driver
USD: Room to Rally
Short-term momentum is swinging back in favour of the dollar as the FX market is finally starting to take the Gulf re-escalation more seriously. Still, both oil ( is at $84/bl this morning) and the USD are showing reluctance to fully price back in another supply shock. That’s despite the US reimposing a blockade in the Strait of Hormuz and oil inventories at worryingly low levels. Overall US crude inventories (commercial+SPR) were 730.8m barrels as of 3 July, the lowest since 1984.
This positive but contained USD reaction does seem a déjà vu of this spring. But conditions are different now. Reduced Fed guidance after a hawkish shift in June means allowing markets to speculate more aggressively on Fed tightening. Markets are now pricing in a roughly 50% chance of a hike in July, and 43bp by year-end.
Fedspeak remains crucial at this stage: yesterday, Chris Waller warned a hike may be needed in the short term if core inflation stays hot. Chair Kevin Warsh starts his first House testimony today, but he may follow his low-guidance approach and give little away. Barr, Goolsbee, Cook and Bowman are all speaking today.
Today’s US June release shouldn’t severely dent markets’ hawkish tendency. should fall month-on-month due to lower energy prices, but at 0.2% MoM isn’t enough to dispel concerns about second-round effects.
Our call for the remainder of the year remains USD negative, primarily resting on another de-escalation and dovish Fed view. But risks, especially in the near-term, are clearly shifting to the bullish side for the greenback, with 102.0 potentially being reached rapidly in if the Hormuz blockade continues.
EUR: Helped by Rates
The EUR:USD short-term rate differential is – for now – helping to keep EUR/USD afloat in this Gulf re-escalation. The two-year swap rate gap has re-tightened around 15bp since the start of July, primarily because the rebound in oil prices happened at a time when ECB hike bets were dwindling, leaving more upside room to recover for EUR front-end rates.
We aren’t convinced this rate gap can offer sustainable support to EUR/USD if energy prices continue to rise though. Markets may find it harder to price in more than two ECB hikes by year-end (now, 46bp) considering the less hawkish stance by ECB officials of late, and the medium-term negative implications of an energy crisis – combined with Fed tightening – for the EUR, tend to outweigh the positive of EUR hikes. The spike in prices is particularly concerning, as it weighs on the eurozone’s terms of trade more than oil.
In a scenario where Brent returns to $90-100/bl and around €55-60/MWh, a move to 1.10 becomes a tangible risk in EUR/USD.
: Best Performer in Gulf Re-Escalation
The Kiwi dollar is the best-performing currency in the G10 since the start of this week, riding the wave of last week’s hawkish repricing after an RBNZ rate hike. It’s a testament to how the FX market is very keen to reward currencies that can offer flexibility on the hawkish side for domestic central bank pricing, not just the positive commodity exposure (like for , , ).
Still, markets are now pricing in 60bp of tightening by year-end in New Zealand, which looks a bit too aggressive before seeing 2Q CPI, which is released on 20 July. AUD should recover some ground over NZD should this escalation fail to defuse.
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
