FX Daily: Fading geopolitical risk, focus on rate differentials
At a Glance
The desk emphasizes that geopolitical tensions in the Middle East have surprisingly failed to bolster the dollar, while focus shifts decisively back to interest rate differentials, as noted in the recent commentary source. Despite the backdrop of escalating US-Iran tensions, including US strikes on Iranian infrastructure and threats of a full blockade of the Strait of Hormuz, the dollar remains relatively stable owing to improving sentiment in risk assets and a decline in oil prices. Front-end rate implications are shifting, with the 2-year USD swap rate having lost ground this week, presenting a broader context where some investors are recalibrating their hawkish expectations for the Fed against improving outlooks overseas; currently 35 basis points of tightening is priced in for December 2023 while the euro has gained on the dollar amid expectations of ECB hawkishness.
Key Takeaways
- 01Dollar remains range-bound despite escalating geopolitical tensions in the Middle East.
- 02Focus has shifted to interest rate differentials, particularly with shifting expectations for the ECB.
- 03Market participants may be underestimating the risks of further conflict and its impact on oil prices.
- 04Fading geopolitical risks have proven successful as a trading strategy at this juncture.
Full Analysis
What the desk is arguing
The desk frames this as a situation where fading geopolitical risks pose a challenge to the dollar, which isn’t gaining traction as one might expect amidst rising tensions. This stems from a fraying relationship between the US and Iran where fresh hostilities — including naval operations in the Strait of Hormuz — are triggering feedback but are overshadowed by rate differential play.
Significantly, the dollar has not reacted positively to the renewed harsh conditions, with the 2-year USD swap rate easing off its recent peak, erasing about half of the earlier rise that followed the geopolitical news. As a consequence, front-end rates are now more sensitive to shifts in other central banks' policies, particularly the ECB adjusting its stance, negatively impacting the dollar's comparative yield allure over the euro.
Market participants could be underestimating the potential for further escalation in tensions, which has historically led to non-linear spikes in oil prices and, subsequently, significant effects on currency dynamics, creating a fragile balance between rate-driven and geopolitically driven trades.
Where it sits in our coverage
For EUR/USD, our internal consensus target for December 2026 sits at 1.1750, with a range from 1.1200 to 1.2000. Notable per-firm forecasts include: - citi: Mar26 1.1300, Jun26 1.1100, Dec26 1.1000 - commerzbank: Mar26 1.1900, Jun26 1.2000, Dec26 1.2200 - goldman: Mar26 1.1800, Jun26 1.2100, Dec26 1.1200
The desk's thesis aligns broadly with the consensus targets, albeit leaning towards the upper end of the range forecasting a reversal through the second half of 2026.
How other firms see it
Several firms, including commerzbank and goldman, express a more bullish view on the euro against the dollar, reflecting recent hawkish swings from the ECB. Conversely, citi and hsbc stand at a more cautious stance, forecasting lower values down the line, indicating less confidence in euro resilience.
The short-term trajectory of USD/JPY is also worth noting as it is closely tied to these FX dynamics, particularly given the BOJ's ongoing ultra-loose policy stance compared to the Fed's potential tightening course.
Market Implications
Traders should monitor the EUR/USD around the 1.1434 level for signs of further recovery towards the upper consensus target of 1.1750. Additionally, risk sentiment and any developments in Middle Eastern tensions will provide crucial context for positioning.
EUR/USD — All Desk Targets
| Firm | Stance | YE 2027 |
|---|---|---|
Goldman Sachs | Bearish | 1.1200 |
UOB | Neutral | 1.1450 |
Citi | Bearish | 1.1000 |
From the original
Articles FX Daily: Fading geopolitical risk, focus on rate differentials Published 07:52 FX Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download A week of revamped Middle East tensions has left the dollar broadly unchanged. Oil prices have come back lower,
Related speeches
4 itemsFX Daily: FOMC minutes can reinforce dollar floor
The desk views the upcoming release of the FOMC minutes as a significant catalyst for reinforcing the dollar's bullish momentum, particularly in a context where geopolitical risks such as US-Iran tensions are not garnering strong market attention. Per the full note, the FOMC minutes are expected to emphasize a hawkish stance by the Federal Reserve, which should provide support for the dollar across key pairs like EUR/USD and GBP/USD. Given that current market positioning reflects a strong belief in further tightening, a hawkish signal will likely consolidate this outlook. This aligns with wider consensus forecasts pointing to a firmer dollar, even as the current spot rates for major pairs remain below long-term targets.
FX Daily: Remarkable resilience of risk assets
The desk interprets the recent uptick in risk asset purchases and dollar selling as a response to perceived progress in US-Iran negotiations, indicating a shift in investor sentiment. Per the full note [source], this development contrasts sharply with earlier fears of a potential oil market tipping point that could lead to a significant spike in crude prices. With no major economic events on the horizon, the focus remains on how these geopolitical dynamics will influence currency movements, particularly the USD's potential downside. The consensus among firms suggests a cautious outlook, with targets reflecting a range of expectations for the USD's trajectory.