How are major central banks and the FX market reacting to the worsening energy price shock?
At a Glance
The desk believes that the Federal Reserve's cautious stance on tightening monetary policy in light of rising energy prices may temper the recent strength of the USD. Per the full note from MUFG EMEA, the Fed's less aggressive approach could signal a shift in market dynamics, particularly as geopolitical tensions in the Middle East escalate. This could lead to a more moderate USD performance as traders reassess their positions amidst the uncertainty surrounding energy costs and inflationary pressures. The consensus among firms shows a range of targets for the USD, reflecting varying degrees of confidence in the Fed's trajectory and the broader economic implications.
Key Takeaways
Full Analysis
What the desk is arguing
MUFG's Lee Hardman and Henry Cook argue that the Fed is showing less urgency to tighten policy in response to the latest energy price shock from the Middle East conflict. This shift could moderate the recent strength of the US dollar by reducing the hawkish policy divergence that has supported it.
Supporting evidence includes the Fed's more cautious stance on rate hikes as energy prices spike, which historically has weighed on the dollar. The analysts implicitly reject the view that the Fed would accelerate tightening to combat inflation, fearing it may deepen a potential recession.
Where it sits in our coverage
Our coverage maintains a moderate USD bullish bias for the near term, expecting EUR/USD to trade around 1.075 by year-end, with a range of 1.04 to 1.12. MUFG's thesis aligns with our view that the dollar may face headwinds as central banks adjust to energy shocks, but we see limited near-term downside.
Specific firm targets from our internal database include: - JPMorgan: EUR/USD Dec-26 target 1.13 - Barclays: EUR/USD Dec-26 target 1.08 - Goldman Sachs: EUR/USD Dec-26 target 1.07
How other firms see it
JPMorgan aligns with MUFG's cautious view on Fed tightening, noting that energy shocks reduce the urgency to hike. Barclays is also aligned, citing similar risks to USD strength from a potential Fed pause. Goldman Sachs is contrary, arguing that persistent inflation from energy will force the Fed to tighten more, supporting the dollar.
Market Implications
Weaker USD, particularly versus EUR and JPY, as Fed tightens less than previously expected. Energy-importing currencies may benefit.
From the original
Lee Hardman, Senior Currency Analyst, and Henry Cook, Senior Economist, discuss how major central banks are responding to the escalating conflict in the Middle East and its impact on global energy prices. With the Fed showing less urgency to tighten policy in response to the late
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