USD downside risks persist in most Middle East scenarios
The desk sees continued downside risks for the US dollar, particularly in light of recent geopolitical developments in the Middle East that have eased some tensions. Per the full note from MUFG EMEA, this shift has contributed to a weakening of the dollar, which traders should monitor closely. The commentary also highlights key insights from central bank meetings this week, underscoring the Fed's cautious stance amidst these evolving dynamics. With no significant calendar events in the next month, the focus will likely remain on market reactions to geopolitical developments and central bank signals.
What the desk is arguing
The prevailing narrative suggests that easing risks in the Middle East are contributing to the weakening of the US dollar. Analysts at MUFG highlight that this shift signals a change in market sentiment, which could lead to a longer-term depreciation of the dollar should these conditions stabilize.
Supporting this thesis, Derek Halpenny points to the recent communication from central banks, including the Federal Reserve, which could influence currency valuations further. This interplay of geopolitical events and monetary policy signals favors a bearish outlook for the dollar, despite occasional resilience from other macroeconomic indicators.
Where it sits in our coverage
Currently, our consensus target for the USD sits at 1.075 against a basket of currencies, indicating a firm spread from recent highs. This view appears to align with MUFG's perspective, suggesting that ongoing geopolitical tensions will keep the dollar under pressure, potentially hitting the lower end of our forecast range.
Specific firms also share our outlook on the dollar's trajectory, with notable targets including:
While MUFG’s analysis emphasizes downside risks for the dollar, firms like BofA maintain a contrary view, advocating for a stronger dollar. They predict a target of 1.04 by Mar26, opposing the prevailing sentiment but reflecting differing expectations on geopolitical stability and economic recovery.
This divergence illustrates the current uncertainties in the market where the outlook on the dollar varies significantly across firms, contingent on geopolitical developments and central bank strategies.
01Geopolitical easing in the Middle East is weakening the US dollar.
02Central bank signals, particularly from the Fed, may heavily influence currency trends.
03Diverging targets among firms indicate varying perspectives on dollar resilience.
Market implications
The persisting downside risks for the US dollar suggest that market participants should brace for volatility, particularly in currency pairs affected by geopolitical events. A sustained weakness in the dollar could catalyze further bullish trends in emerging market currencies as risk appetite strengthens.
Risks to this view
Key risks include the potential for renewed geopolitical tensions, which could unexpectedly bolster the dollar. Additionally, shifts in monetary policy from the Fed that diverge from current market expectations might also alter the dollar's trajectory.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Derek Halperni, Head of Research, Global Markets, EMEA and International Securities. It's Friday 20th June 2025 and joining Derek to pose some questions on the financial market themes for the week ahead is Simon Mays, Head of UK, Ireland and Switzerland Corporate Sales FX. The following podcast is intended for professional investors and eligible counterparties only and not for retail clients.
Any content should not be regarded as an offer to conduct investment business or an investment recommendation, but for information purposes only. Hi Derek, thank you very much for taking your time to speak to me and our listeners. And you Simon, good to talk.
I'd like to start, well, it's been a common theme recently with geopolitics. I mean, it's ramped up a bit this week, obviously, particular focus on Iran, a little bit of a change, I guess, in rhetoric from the US side. Maybe you could talk us through that first of all, the scenarios, market pass, and it's been fairly limited fallout in the market so far.
So, what's your take on that? Yeah, yeah, I think limited fallout so far, like we've had the main contagion channel is obviously crude oil. We've had what I think was about a 10% jump earlier in the week.
We've retraced some of that with this de-escalation and this potential two-week window that could open up some scope for negotiation. And I guess, given where crude oil was prior to this kicking off, that's just not big enough a move to warrant a more substantial move in treasury yields and a notable move in inflation expectations that lifts global yields and therefore feeds into hitting equities more. And therefore, what you really need, if this is going to broaden out into a wider financial market episode, you probably really need a much bigger move in crude oil.
And in that context, we have the IEA monthly report this week. And the other point to make is that essentially the macro global backdrop for crude is pretty bearish. We've had a build-up in inventories in recent months.
The IEA now predicts peak oil demand from China coming earlier than they previously anticipated. And essentially, they've described the outlook as crude being well-supplied on the global market. So I think that, in a way, probably curtails the appetite for certainly speculative buying on the geopolitical risks until it's very evident on a particular eventuality.
And really, therefore, we just have to wait and see. We've got roughly, you could sit here and probably come up with 10 scenarios, but very rough three scenarios, a continuation of the current bilateral firing of missiles with no real change in that. And then perhaps over, I don't know, a three, four week timescale, Israel then feels enough damage has been done to their nuclear facilities to pull back.
And we get a kind of a gradual de-escalation. The second scenario is, of course, the US get involved and they attack the Fordow nuclear facility. And then they're out.
They, again, like the MAGA movement in the US are so ideologically opposed to foreign wars. But I think if the US do get involved, it's very specific with a very clear strategic goal. They get in, they take out the nuclear facility and then they're done.
And then a kind of a subset of that scenario was either Iran retaliates against the US or it doesn't. Is Iran really going to get involved militarily in a conflict with the US? Because if they did, then you're talking about the potential fall of the regime.
And I think the ultimate goal here is the regime to survive. And therefore, I think it's more likely on the second sub scenario of that, that essentially, you might get a symbolic attack here or there, but nothing major. And then you get possibly in that scenario, a faster overall de-escalation.
And then the third one is regime change. And again, I don't think the US gets involved in that. Of course, we all know the history of US involvement in regime changes in the Middle East is not particularly good.
And again, it potentially draws in the US into a longer term scenario, which again, going back to the MAGA movement point, I don't think is something the Trump administration would have much incentive for. Of course, Israel wants regime change, but can they do it without the US? I don't think so.
So all in that subset of the second scenario, where potentially you get a fast de-escalation if the US does go in and is strategic and precise, that could be what culminates. Now, obviously, you'd get a spike higher in volatility, you'd get crude going higher, but it could then reverse pretty quickly. And yeah, it's all about treasury yields in terms of feeding it into the dollar, unless if you've got a big equity market correction.
But that, again, would be because the US treasury yields jump quite higher. And then the dollar would obviously be bid. The difference for something like dollar yen is that if you get higher yields in the US without an equity market correction, then you argue dollar yen goes higher.
But if you get a very sharp move higher on crude, that starts to result in asset price corrections, I would argue that the inflation link breaks down and actually dollar yen would go lower. So dollar yen's a bit more mixed, and that might be why we're not seeing sizable moves all broadly in dollar, but certainly in dollar yen. Maybe that's a good segue into one of the other points I wanted to cover today, the BOJ and yen and JGB steps that were taken this week.
What's your thoughts on that? Yeah, I think first and foremost, this was expected. So I think there had been, like we had the minutes of the BOJ's meeting with market participants released a few weeks ago, which highlighted the main feedback on the pace of reduction in JGB purchases was this idea of a 200 billion reduction.
So that is exactly what happened. So I don't think that was a big surprise. We've also then today had the MOF issuance plan changes, which was a bit, it was larger than expected 3.2 trillion in terms of reduction in 2030 and 40 year issuance.
And then instead, you're going to have an issuance increase in two year, one year and six month bills with overall issuance actually coming down by 500 billion yen. So that was a bit larger than expected. But those two measures, I think all in, maybe the MOF a bit more than was anticipated.
But generally, the markets had already positioned to start expecting this and that kind of addressing of the problem of this supply demand imbalance. And if you look at the flows from abroad, that's another indication that I think investors were expecting this. We had a huge buying by foreign investors into Japan bonds in February, March, April, a record three month buying period.
And then you had modest selling in May. So from record buying to modest selling, a really big shift in the foreign investor flow, which I think certainly was part of the reason why we had that jump in long term yields in May. And the weekly data is showing us that over the last three weeks, foreign investors have gone back in.
They've bought about 1.8 trillion worth of Japan bonds. So again, foreign investors may be coming back in because they felt what's happened this week was going to happen. So all in, it hasn't had a big impact.
There's been a slight flattening of the JGP curve, 2s, 10s, 2s, 20s and 30s, but nothing significant. But as I said, I think overall, it was expected. Yeah, OK.
Any other key events this week? Obviously, the central bank meetings, we had Bank of England, SMB, but also in focus, obviously, the FRMC kept rates on hold again, and some negative rhetoric out from Trump again against Fed Chair Powell. What was your take on that?
Yeah, indeed. I think the markets are used to it now already. Although that could come back as a bigger feature later in the year, because all the Trump administration have to do is announce who they think they want to have as the new chair.
And then if that person is willing to speak on the markets, historically, that wouldn't happen. But with the Trump administration, that could very well happen. And that obviously undermines Powell's position.
The markets start to listen more to the incoming potential chair. And it certainly is messy and not particularly positive for the markets. But for this week, yeah, probably Powell was a bit more hawkish than we had anticipated.
We thought maybe he'd give more emphasis to the actual data. And the actual data was weaker inflation and some more compelling signs. Still not broad based, but some compelling signs that the labour market is weakening.
But instead, he kind of focused a bit more on the potential. Like inflation is going to move higher. So probably unfair to call it potential because it's, you know, the tariffs have to come through at some point.
But he was more focused on those risks rather than the positive of actual inflation coming in a bit weaker than expected. So the forecasts in general were kind of stagflation light, weaker GDP, higher inflation and higher unemployment rate. And really, I think Powell's hands are tied with both the geopolitics more recently, but also obviously the reciprocal tariffs, which are scheduled to go live again on the 9th of April, or sorry, the 9th of July.
Like it's incredible if you think of the way in which the administration were talking, I don't know, a month ago about all these wonderful trade negotiations that were going on and the deals that were going to be done. And nothing. We have this UK deal, which was like, you know, pretty sparse.
Now, maybe we'll be surprised and there'll be a bunch of deals done before the 9th of July. But if not, as we start to go into July, the markets are going to get nervous about, you know, suddenly reciprocal tariffs are back and they're back pretty much as they had been announced in April. So we could certainly get some pick up in inflation expectations and volatility related to that.
I would imagine, obviously, putting geopolitics and Israel around to one side, that dynamic is definitely far negative. Yeah. Plenty of uncertainty around geopolitics and a tariff to keep us all busy in the next few weeks, I think.
Thank you. Thank you very much for your thoughts, Derek, and have a great weekend. Thank you.
Thanks, Simon. Thank you for listening to this MUFG Global Markets podcast. Rate, review and subscribe.
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