How are Middle East risks & intervention contributing to a weaker USD?
At a Glance
The desk posits that the recent weakening of the USD is largely driven by optimistic developments in Middle Eastern geopolitics, particularly regarding potential negotiations between the US and Iran. Per the full note from MUFG EMEA, this optimism has buoyed global risk sentiment, contributing to a rally in equity markets and a decline in the dollar's value. Additionally, strong earnings growth from US corporates has not translated into dollar strength, as the Federal Reserve's current stance suggests a hold on interest rates. This aligns with our consensus target of 1.075 for the EUR/USD, reflecting a range of expectations from various firms.
Key Takeaways
- 01Middle East risks are weakening the USD.
- 02Japanese intervention may not fully reverse JPY depreciation.
- 03Investor sentiment is crucial in determining USD-JPY dynamics.
Full Analysis
What the desk is arguing
MUFG analysts Lee Hardman and Seiko Kataoka Fisher argue that heightened risks emanating from the Middle East are contributing to the recent depreciation of the USD. This trend is compounded by speculation surrounding the potential effectiveness of Japanese government intervention in stabilizing the JPY, which has been under pressure against the dollar.
The analysts provide evidence that persistent geopolitical tensions have shifted investor sentiment, favoring currencies seen as safe havens. Furthermore, they posit that if Japan does proceed with intervention, while it may provide temporary relief for the JPY, it is critical for the broader market sentiment to stabilize to have lasting effects on USD performance.
Where it sits in our coverage
Our current consensus target for USD/JPY is 1.075, resting within a range of 1.04 to 1.12. This outlook aligns with MUFG's perspective on potential vulnerabilities facing the USD due to shifting risk landscapes, albeit with varying interpretations of the intervention's immediate effectiveness.
- Barclays: Dec-26 target at 1.10.
- JPMorgan: Dec-26 target at 1.10.
- Morgan Stanley: Dec-26 target at 1.08.
How other firms see it
In general, sentiment appears divided among major firms regarding USD performance amidst geopolitical tensions. Some analysts are more cautious, suggesting that external factors may play a more prominent role than domestic interventions.
- Goldman Sachs: Aligned, citing stable fundamentals supporting the JPY recovery.
- BofA: Contrary, warning of potential for further USD strength against JPY in the absence of effective intervention.
Market Implications
A weaker USD can lead to stronger Japanese exports, potentially stabilizing risk markets. However, the effectiveness of Japanese intervention could be limited, leading to ongoing volatility if geopolitical situations worsen.
From the original
Lee Hardman, Senior Currency Analyst, and Seiko Kataoka Fisher, Director in Japanese Customer Sales for EMEA in London, discuss what has been driving the USD lower over the past week . Is intervention from Japan likely to be successful in reversing JPY weakness?
Related speeches
4 itemsHow has the USD been impacted by geopolitical risks?
The USD has experienced a notable correction lower despite rising US yields, primarily driven by geopolitical risks and market sentiment shifts. Per the full note from MUFG EMEA, analysts Lee Hardman and Sara Maki highlight that the recent decline in the USD reflects a complex interplay of factors, including heightened geopolitical tensions that have influenced investor behavior. This dynamic suggests that the currency's trajectory may be more sensitive to external shocks than previously anticipated, particularly as global risk appetite fluctuates.
What’s behind the latest USD sell-off?
The recent sell-off in the USD is attributed to a combination of factors, including waning confidence in US and Japanese debt markets, as highlighted by MUFG EMEA analysts Lee Hardman and Abdul-Ahad. This sentiment shift has raised concerns about potential spillover effects into the FX market, particularly as investors reassess risk appetites amid rising yields and inflationary pressures. Per the full note [source], the USD's decline is reflective of broader market anxieties, which could have implications for currency valuations in the near term.
Yen intervention risks failure as Iran war clouds Japan's currency defence
The desk views the recent Japanese yen intervention as potentially the least effective in recent history, primarily due to the unpredictable geopolitical landscape stemming from the Iran conflict. Per the full note from MUFG, the intervention, estimated at JPY5-6 trillion (approximately $32-38 billion), has provided only temporary relief as dollar-yen fell from near 160 to below 157. With the Federal Reserve's policy direction and Bank of Japan rate hikes critical for a sustainable move lower in dollar-yen, the desk highlights that the current geopolitical risks complicate the outlook. The consensus among firms leans towards cautious optimism, but the lack of imminent high-impact calendar events suggests limited immediate catalysts for a significant shift.
Middle East Tensions and the FX Outlook: De Escalation vs. Deterioration
The desk posits that the ongoing Middle East tensions are likely to lead to a significant impact on FX markets, particularly if crude oil prices escalate further. Per the full note from MUFG EMEA, the current scenario suggests that if crude remains between $85 and $120, the DXY could strengthen by 4%, while a shift to the $120 to $160 range could see it rise by 7-8%. This volatility is compounded by the current geopolitical landscape and the unpredictability of U.S. policy responses, particularly under the Trump administration's influence. As such, traders should be vigilant about potential shifts in risk sentiment and their implications for currency performance.
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