The world of foreign exchange (FX) is a delicate dance, and today we're witnessing a cautious step towards de-escalation. President Trump's recent claims about negotiations with Iran being in their 'final stages' have sparked a cautious market response.
In this article, we'll delve into the nuances of this de-escalation trade, exploring why the market's conviction is lower this time around and what this means for the USD and other currencies.
A Cautious Dance with the Dollar
The USD has shown a more resistant stance to de-escalation headlines, and for good reason. Markets have been burned before by optimistic headlines, and the rhetoric from both the US and Iran remains aggressive. This time, the market is taking a more cautious approach, with a reduced intraday fall in the DXY index compared to previous attempts at a peace deal.
What makes this particularly fascinating is the role of market memory. The FX market, like any other, learns from its experiences. The disappointment of earlier negotiations has left a mark, and traders are now more hesitant to jump on optimistic headlines. It's a prime example of how market sentiment can shift based on past events.
Hawkish Fed and Sticky Yields
The macro backdrop further complicates matters. The FOMC minutes revealed a hawkish Fed, with members discussing the possibility of signaling a rate hike. This has made it harder to bet against the dollar, as Treasury yields may stick to the downside. Even with de-escalation headlines, the Fed funds futures curve still prices in a tightening by December.
In my opinion, this highlights the delicate balance the Fed must strike. While a rate hike could strengthen the USD, it also carries risks. A tighter monetary policy could impact the broader economy, and the Fed must carefully navigate this path.
Thinner Market Patience
The dollar's reaction to Trump's comments is a telling sign. While there's scope for further USD downside if a deal is agreed, the market's patience is wearing thin. A new period of stalled negotiations could push DXY above the 99.50 mark, even without military re-escalation. This raises a deeper question: how long can the market maintain this cautious optimism?
EUR and the ECB's Non-Commitment
Turning our attention to the EUR, we find the ECB taking a cautious approach as well. A Reuters report suggests the ECB won't promise a July hike after a June increase. This is a strategic move to manage expectations, especially as the inflation outlook shifts.
Personally, I find it intriguing how central banks navigate these delicate situations. The ECB's non-commitment is a clever way to avoid overpromising and potentially disappointing markets. It's a fine line to tread, and the ECB seems to be doing so with precision.
AUD and the RBA's Pause
In Australia, a soft jobs report has hit the overbought AUD. Unemployment rose, and PMIs were grim. This has endorsed the Reserve Bank of Australia's cautious stance after the May rate hike. Our call remains for no further hikes, despite market expectations.
However, our dovish view on the RBA doesn't translate to a bearish AUD/USD outlook. We see greater downside risks for USD yields, and the AUD's fundamentals and carry story remain attractive. While corrections are inevitable, we maintain a strong conviction for AUD/USD gains by year-end, assuming a Middle East agreement.
CEE and the Oil Price Link
Yesterday's US-Iran talks brought optimism to the CEE region, with markets quickly pricing in tightening. Our model reaction aligns with this, suggesting a 10 USD/barrel change in oil prices implies a 20bp change in 1y1y rates for PLN and CZK. FX rebounded, but the story remains within previous ranges.
Today, we'll watch Poland's wage figures, industrial production, and PPI. While wages are a favorite indicator for the National Bank of Poland, PPI and agricultural prices could provide insights into the impact of the US-Iran conflict on inflation.
In conclusion, the FX market is a complex web of interconnections. From the cautious de-escalation trade to the strategic moves of central banks, every action has a ripple effect. As we navigate these uncertain times, one thing is clear: the market's memory and patience will play a crucial role in shaping currency movements.
