Middle East Tensions and the FX Outlook: De Escalation vs. Deterioration

Welcome to the MUFG Global Markets FX Week Ahead Podcast with Derek Halpenny, Head of Research, Global Markets, EMEA and International Securities. It's Friday 27th March 2026 and joining Derek to pose some questions on the financial market themes for the week ahead is Chris Jakubowski, Head of Hedge Fund FX Sales. This material is only intended for professional investors in jurisdictions in which its use is permitted under applicable laws, rules and regulations.

It has been produced for information purposes only and should not be construed as investment research or advice. MUFG EMEA disclaimers and disclosures can be located on our website. Hi Derek, how are you?

I'm good Chris, yes, how are you? Yeah, keeping my head just above water, shall we say. Markets have been wild, so let's just start with that.

I think we've got to dive straight into just having a quick chat about the Middle East and probably task you with the impossible question of where you think it will go because arguably I think it's probably one of the hardest questions to answer and I think that's probably down to the fact, well, one of the reasons as well that the market's just so volatile in the sense that people just can't predict where it's going to go because the nature of it is so unpredictable because it's being driven by the Trump administration who arguably don't have answers which need answering and I think have dug themselves a hole they can't really get out of and they're trying their hardest now to get out of it with negotiations, shall we say, apparently happening between the two of them. But look, oil's still up, equities tanking, the dollars bid, inflation remains a serious, serious concern for not only the markets but also individuals and I think that will come through in sort of political voting in due course but, you know, where are we at? Probably easier, it's where are you at?

Where's your head and where do you think we go from here and in the next couple of weeks? Yeah, like I guess regular research readers, listeners will have heard that we, you know, we kind of laid out three rough scenarios. In the first week we published that and the scenarios had ranges for crude and FX impact and scenarios, scenario one which is the best case that's gone past really and it's either scenario two, scenario three.

Scenario two was basically crude oil between 85 and 120 and scenario three was 120 to 160 and obviously we're kind of, from that perspective, we're in scenario two and we're potentially drifting towards scenario three. Now, the difference obviously is partly time, obviously, because the longer the Strait of Formosa remains closed, the more you get upward pressure on crude oil prices and we start to move into scenario three and also potentially an escalation in terms of the time. And just for clarity, this is spot crude?

Yes. Yeah. Yeah.

Yeah. And then you have energy production facility attacks escalating and then supply concerns and reassessments of supply projections forces crude oil prices higher. In that, in scenario two, we have DXY up, you know, maybe something in the region of unchanged to 4% stronger and then in scenario three, a worst case scenario potentially DXY moving up by about 7, 8%.

Scenario three involves other aspects starting to fall into play. You mentioned equities have, you know, they're certainly down today, but when you look at the bigger pictures at the beginning of the conflict, you wouldn't really describe equities as having yet tanked. You know, VIX, for example, has gone from 20 just before the conflict began, we're touching around 30.

You know, if you go back to Liberation Day, we spent nearly three weeks between 30 and 50, 55 on VIX. So we're still relatively contained from a risk perspective. But if we move into that higher crude oil range, then I think you're going to get investors started to price in greater risks of global recession.

That's when equities start to come under bigger pressure to the downside. And then I think the FX performance in terms of G10 starts to change. Like at the moment, I think in terms of trade and yield is still having an influence in terms of G10 FX performance.

So beyond the dollar, which is stronger against all of the rest of G10, sterling is the next best performing currency. And then you've got, you've got CAD and NOKI, second and third best performing. So sterling, you know, a bit of a head scratcher, maybe yield, obviously front end yields have moved the most in the UK, you know, two year up over 100 basis points.

OAS pricing for this year has gone from two cuts to three hikes, so it's 125 basis point swing. So, you know, that's the logic maybe in terms of sterling's performance. And then obviously in terms of CAD and NOKI, you've got the terms of trade.

But if equities start to tank and then we get into a broader risk all related to global growth, I think the dynamic starts to change. I think yield becomes less important. Therefore I think sterling underperforms and we could see a pretty notable correction lower in sterling.

And then I think, you know, for example, well, certainly NOKI, CAD, Aussie, Aussie is already slipping at the table, which might be an indication of broader risk starting to become an influence. I think NOKI and CAD would suffer as well. And then the likes of Swiss franc, which is towards the bottom of the G10 performance table, I think would certainly move up towards the top end.

SMB intervention, yes, that's a factor since the SMB policy meeting that may be resulting in underperformance, but I go back to what I said. VIX is still relatively low. We haven't really seen a big risk off move.

If that starts to unfold, I would certainly expect the Swiss franc to outperform. Do you think do you think it will? I mean, do you think they do you think Trump will let it go on that long, though, for crude to remain elevated?

I know it's obviously he's in the hole, so it's not completely his choice. But I think he sort of found himself in a difficult position now and he probably wants to get himself out of it as quick as possible. I totally agree with everything you said there.

But I just feel that if he doesn't do something quickly, I mean, I think he's already going to struggle now with the passer effects from what's been done for his midterms. But do you not think he wants to get this done quickly? I mean, Rubio's over now in G7.

He's trying to talk to them, you know, and and try and sort of get some support there. And I wonder how much they are helping probably more diplomatically. Well, they're helping diplomatically potentially, but not so much sending ships there, which I don't think is the resolution anyway.

But in some form, it feels like there's more efforts being made to broker something. And I think a lot's probably happening behind the background between other nations as opposed to just the U.S. because I don't know how much the U.S. is doing. But U.S. needs other people's help to broker this, whether it be, you know, another country or something.

So do you think there will be, you know, an effort for him to sort of step back and allow something to be done? Yeah, I don't like I don't like I think that effort has been evident this week. But, you know, it's not as simple as Trump clicks his fingers and we have de-escalation.

No, quite the opposite. There's four players. There's there's Middle East countries who, from speaking to colleagues and other people in the Middle East, what what's being kind of heard out there, for example, is that a lot of these countries wouldn't accept that the Iranian regime staying in power after World War II.

So the Middle East countries are one actor in all of this. Israel is another. And then, of course, Iran and then, of course, the United States.

So let's say there's another big push. I think obviously one of the most important players is Iran. So if you're Iran and you're thinking, OK, if I go into negotiations, let's say next week, what's my leverage next week compared to my leverage maybe in a month's time or six weeks time when things have got a lot worse?

The economic impact is more severe. The political pressure on resilience is definitely higher. So there is an incentive for Iran to actually genuinely reject any kind of approaches over the short term.

Now, you know, that's the public comments we're getting from Iran. So we don't know if that's what's happening in private. And I'm sure if there was deals done that they could be happy with, we could reach a deal.

But if you look at the 15 point plan from the US and then the five point plan rebuttal from Iran, you know, they're poles apart. So it doesn't look like there's going to be any deal on that. So in that sense, I still think it's quite difficult over the short term to to get to that point.

So what we're kind of thinking now is that we're going to get escalation. We're going to go into scenario three crude oil into new highs above 120. And then you get a bigger risk off.

And then maybe that doesn't last for too long. And how long do you think? Well, you could still measure it in weeks.

But certainly by, you know, end April into May, you're you're in you're in you're in de-escalation. That's a kind of a rough guide. Like we're going to be updating our forecast next week.

We're certainly still going to show dollar weakness. What would be further out the forecast? Would you reckon then at that point, then what would fuel de-escalation then that won't now?

What the US rolling back on nearly everything and then just sort of Trump walking away and says, oh, I've, you know, got rid of their nuclear power and so washing his hands of it and walking away. Yeah. Well, I guess there's going to be by that point in time, there's going to be two, three, four more weeks of weakening the infrastructure in Iran for retaliation and military strength and nuclear capabilities.

So the longer it goes on, the stronger the political messaging communication from Israel and from the US in terms of we've done the job. And as I said earlier, Iran is at a position where maybe they feel they've got a bit more leverage and a deal is done and that allows for some kind of de-escalation. So then a year from then, what do you think?

So that sort of Larry thing, I don't know if you saw as well, he was saying it's going to sort of be two polar ends and not in the middle. And in a year, either Brent will be at 40 or 150. And, you know, even though they'll either be brought back into sort of the system and, you know, the produce, i.e. oil, will be allowed to be taken back into the market.

And then, you know, you'll have enough supply to be able to bring that down. Do you think that the oil markets, you know, in a year will be back? I don't know.

I think I find it like if the regime in Iran stays in power, there in my mind, it's inevitable that there's going to be a fairly substantial geopolitical risk premium that will remain in the price. And there will always be some degree of uncertainty in terms of the strategic models and the potential for re-escalation. In that context, I'd be surprised if we were back at 40 in a year's time.

Yeah. If the regime is removed and there's a more Western aligned regime in power, yeah, then potentially that could take place. But what I would say in terms of FX to your question, you know, the dollar is not strengthening as much as we thought it would be at this point in time, given where crude oil is and given what's starting to happen to equities.

And maybe we'll get a bigger move stronger now in the next week or so. But, you know, I do still think if you go back to January, if you go back to, you know, pre-conflict, we had that big debasement fear about the dollar and, you know, gold and silver going through the roof. And there is an underlying weak fundamental backdrop for the US dollar.

And I don't think that's gone away. And it might be influencing the scale of dollar strength that we're getting at the moment. And if we do get de-escalation, I think you move further out.

The Fed is going to be the first to start cutting in a de-escalation scenario. We actually now think the ECB are going to raise rates. Yeah.

We think the Bank of England will probably raise rates as well. Yeah. So the reaction function has changed completely for an energy price shock.

And that means the scale of dollar strength might be less. And then once de-escalation arrives, the fundamentals are certainly still weak for the dollar and we see dollar depreciation. OK.

So you touched on the ECB and on the Bank of England. We saw those front end rates flying. What about BOJ, though?

Obviously, we had all the expectations were for two more hikes there. But we're up at 160 and it's hovering around there. And it's, you know, it's not coming down.

What are your expectations for dollar yen? Well, based on what I was just saying there, I think dollar yen is definitely going to go higher. So I think we're, well, obviously, I think 95 is the high today.

So we're nearly through it already. But if the dollar is going to extend further, yeah, I think we're going to break hard. Now, again, going back to what I said earlier in terms of the dynamic in FX starting to change, if equities becomes the falling equities becomes the risk aversion type trade, the end then versus the dollar might not move as much.

But I still think we're going to break above 160 in the meantime. And then it's about intervention. When does it happen?

I'm not sure it'll happen immediately. The fundamental backdrop is obviously a bit more challenging for any kind of successful intervention. A tail risk, it's not our view, but it's worth mentioning, is joint intervention.

Yeah. The Fed checked rates in January. The Trump administration, in general, don't like a stronger dollar.

If they want to send a message to the markets that they don't want the dollar to strengthen during this conflict, joint intervention would certainly be one way of doing that. I still don't think it happens, but it's worth keeping it. Yeah.

OK, cool. That makes sense. And then the BOJ, we have them raising rates in April.

Twice, right? Yeah, twice in total. Next one.

When do you reckon? October, December then, or the next one after that? Again, assuming de-escalation has taken place by then.

Yeah, yeah, definitely. Definitely. So they actually upgraded their range for the neutral or the R-star estimate.

It's pretty much the same. Do you think they go in April, right? Yes, they do.

Yeah, yeah. Still. So they've announced a new CPI measure yesterday.

It's a measure that incorporates excluding policy steps that have impacted inflation. So subsidies on energy, mobile phone charges, COVID-related policies, all of that. They've incorporated that into the index.

And that's on an ex-fresh food nationwide basis, excluding policy measures. The annual rate is currently at 2.2. OK.

That's versus a 1.6 actual level of nationwide. So it tells you the message, I guess, is to a degree that they're achieving their policy stance. And there's certainly justification there for a hike in output.

Yeah, good. OK, then quickly, let's move to the week ahead and sort of what's coming. And I think there's probably some US data.

Well, there's the non-farms, there's US retail sales as well, I believe. And then there's EU inflation. We chatted on it briefly earlier as well.

Do you think that you're going to start seeing sort of the effects coming through of the war in European inflation and retail sales and the NFP? Yes. Yeah, the energy impact in terms of the particular retail fuel at the pumps, you know, that will be captured in the data.

And I think then more pronounced will be the month after. So it'll start to play through for sure. And again, I just think the ECB have actually got the best credibility in terms of having achieved their inflation target post the global inflation shock.

The Fed haven't done that. The Bank of England haven't done that. So they have credibility in that regard.

But because they've achieved their target, the policy rate is actually neutral. Whereas for the Fed and the Bank of England, they still have a restrictive stance. So for that reason, the stance being neutral, we think the ECB would probably be quickest to move.

And they want to get on top of us. The, you know, Lagarde's message when she gave her speech this week was very, very clear. They're not going to hang around.

And they probably see the value in preempting and taking the risk of doing it when they shouldn't have rather than waiting too long like they did in 2022. So yeah, there'll be evidence in the data, I think, for sure. In the US, payrolls obviously is the big one.

But we also have the AGP and the JOLTS report. In general, obviously, the 92,000 drop in payrolls was strike related, weather related. That will reverse.

And we're back to maybe what was the average pre that drop. So the consensus for Friday is around 50,000. And there is some uncertainty.

The birth to death model has changed. So that's kind of skewing the data a little bit. So there is maybe a higher risk of another surprise print.

But obviously, I think it'll be better than the drop we had last month. And yeah, lots of other data. The one I would highlight to listeners to have a look out for is the ISM manufacturing on Wednesday.

Not for the overall print, but of course, the price is paid. That jumped last month to 70. The 2022 highs were between 80 and 90.

So it's very feasible we could get a big drop in prices paid on. OK, fantastic. Well, in between then and now and then, we'll keep our fingers crossed for some sort of de-escalation.

And there's nothing else to say now. We'll close the call. Indeed.

Great. Have a good weekend. And you.

OK. Cheers. Thanks, Derek.