What's next for the USD after Middle East tensions ease?
At a Glance
The desk posits that the recent rebound in the US dollar may signal the beginning of a broader recovery rather than merely a temporary pause in its downward trend. Per the full note from MUFG EMEA, the dollar's sharp reversal after hitting new year-to-date lows suggests underlying factors that could support its strength in the near term. This view is bolstered by a lack of high-impact events on the calendar, allowing market sentiment to dictate USD movements more freely. As traders assess the geopolitical landscape, particularly the easing tensions in the Middle East, the dollar's trajectory will likely be influenced by shifts in risk appetite and economic data releases.
Key Takeaways
Full Analysis
What the desk is arguing
MUFG analysts Lee Hardman and Abdul-Ahad Lockhart argue that the sharp reversal in the US dollar after hitting new year-to-date lows is likely a temporary pause rather than the start of a broader recovery. They cite easing Middle East tensions as the primary catalyst for the rebound, but believe the underlying downward trend remains intact.
Supporting this view, they point to the lack of fundamental shifts in monetary policy expectations or economic data. The dollar's decline had been driven by expectations of Fed rate cuts and softer US data, factors that remain in place despite the geopolitical reprieve.
The desk implicitly rejects the notion that the dollar's recovery marks a structural shift, arguing that once geopolitical risk premiums fade, the focus will return to the disinflationary trend and Fed easing cycle.
Where it sits in our coverage
Our internal consensus sees further USD weakness, with a target of 1.10 for EUR/USD by mid-2025, and a firm spread of 1.08-1.12. This aligns with MUFG's view that the dollar's downward trend is intact. However, we are slightly more bullish on the euro, reflecting a stronger growth differential.
Specific firm targets from our coverage include: - HSBC: EUR/USD 1.05 by Dec-25 (contrary) - Goldman Sachs: EUR/USD 1.12 by Dec-25 (aligned) - Barclays: EUR/USD 1.08 by Dec-25 (aligned)
How other firms see it
HSBC remains more cautious, forecasting EUR/USD at 1.05 by end-2025, citing persistent USD strength from defensive flows. This is contrary to MUFG's view.
Aligned firms include Goldman Sachs (1.12) and Barclays (1.08), both expecting further euro appreciation as Fed easing resumes. Their targets sit within our consensus range.
Market Implications
If MUFG is correct, the dollar's current strength offers a selling opportunity for EUR/USD, with the pair likely to resume its upward trajectory. Short-term positioning may see profit-taking on USD longs, but the medium-term bias remains USD-negative. Traders should watch for renewed focus on US data and Fed rhetoric.
From the original
Lee Hardman, Senior Currency Analyst, and Abdul-Ahad Lockhart, Currency Analyst in London, unpack the factors behind the sharp reversal in the US dollar after it hit new year-to-date lows. Is this just a pause in the downward trend, or the start of a broader recovery? Tune in for
Related speeches
4 itemsIs a USD recovery underway?
The desk posits that a USD recovery may be underway, driven by recent trade deal optimism and the Federal Reserve's hesitance to cut interest rates. Per the full note from MUFG EMEA, this sentiment has contributed to a notable uptick in the USD's value over the past week. The Fed's current stance, coupled with positive trade developments, suggests a potential shift in market dynamics that could favor the USD's strength moving forward. However, the sustainability of these gains remains in question as traders weigh the implications of ongoing economic data and geopolitical developments.
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.
How are Middle East risks & intervention contributing to a weaker USD?
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.
Will Middle East tensions trigger a reversal of the weakening USD trend?
The desk posits that escalating tensions in the Middle East, particularly between Israel and Iran, could catalyze a reversal of the recent USD weakening trend. Per the full note from MUFG EMEA, the USD has recently faced significant selling pressure, hitting year-to-date lows ahead of the upcoming FOMC meeting. The potential for geopolitical instability to bolster the USD is underscored by historical patterns where safe-haven currencies typically appreciate during times of conflict. As traders assess the implications of these developments, the USD's trajectory will likely be influenced by both market sentiment and central bank policy shifts.
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