FX Market Update: Dollar Strengthens as Energy Shock and Geopolitical Tensions Drive Volatility.
USD – Strengthening as safe-haven demand rises amid escalating geopolitical tensions and surging energy prices.
EUR – Facing pressure as rising energy costs weigh heavily on the eurozone’s outlook.
GBP – Mixed performance, with shifting Bank of England rate expectations providing some underlying support.
USD:
The dollar is trading in a stronger position as markets adjust to the prospect of a prolonged conflict in the Gulf. Oil surged close to $120 per barrel at the start of the week, boosting demand for safe-haven assets and supporting the dollar. Developments in Iran have reinforced expectations that tensions could persist, with the appointment of the son of Ayatollah Ali Khamenei as the new Supreme Leader signalling a continuation of the country’s hardline political stance.
Oil prices have eased slightly after reports that G7 leaders will meet to discuss the potential release of strategic oil reserves, although this is unlikely to materially change the outlook if hostilities continue. With higher energy prices raising inflation concerns, rate expectations have shifted significantly. Markets are now pricing in only one US rate cut this year, a notable repricing from previous expectations.
Attention this week will turn to Wednesday’s US CPI inflation data, though the geopolitical backdrop is likely to dominate market sentiment and reduce the impact of backward-looking economic releases.
EUR:
The euro is currently being driven largely by developments in the energy markets. Rising oil and gas prices have put significant pressure on the eurozone outlook, pushing EURUSD to its lowest level since November. The Dutch TTF gas benchmark has surged more than 100% year-to-date, while Brent crude has risen sharply, compounding the strain on an economy that is heavily reliant on imported energy.
This dynamic contrasts sharply with the US, which benefits from being a net energy exporter. As a result, the deterioration in the eurozone’s terms of trade is weighing on the currency. Should energy prices continue to climb, further downside pressure on the euro is likely. Conversely, any signs of an earlier-than-expected de-escalation in the conflict could provide scope for a rebound.
GBP:
Sterling continues to follow a mixed pattern. GBPUSD has edged lower in line with broader dollar strength, while GBPEUR has been gradually trending higher as the euro comes under pressure from energy market developments.
Expectations around Bank of England policy have shifted dramatically in recent weeks. At the end of February, markets were heavily pricing in the possibility of a near-term rate cut, with an implied probability of 86% for a March move. This morning, sentiment has flipped significantly, with markets now assigning a 71% probability that the Bank of England will raise rates by December.
Sterling’s direction this week is likely to depend heavily on geopolitical developments and movements in energy markets. On the domestic side, investors will also watch a speech from Bank of England Governor Andrew Bailey on Thursday, followed by the UK’s monthly GDP release on Friday, both of which could provide additional clues on the policy outlook.