What's next for the USD after Middle East tensions ease?
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.
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.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01MUFG sees the dollar's rebound as temporary, driven by geopolitical factors, not a trend reversal.
- 02The broader macro backdrop still favors a weaker USD on Fed rate cut expectations.
- 03Our consensus aligns with a continued euro uptrend, targeting 1.10 by mid-2025.
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.
Risks to this view
A sustained escalation in Middle East tensions could keep the dollar bid as a safe haven. Additionally, if US economic data surprises to the upside, delaying Fed cuts, the dollar could rally further. Conversely, a sharp downturn in US data would accelerate the USD sell-off, potentially overshooting expectations.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday, 27th June 2025, and joining Derek to pose some questions on the financial market themes for the week ahead is Abdul Ahad Lockhart, Currency Analyst. 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 Lee. Hi Abdul Ahad.
So it's been a busy week in FX markets. The dollar has seen a sharp turnaround over the past week, falling to fresh year-to-date lows. What has been the main trigger of this selloff?
Yeah, at the start of this week, the dollar was trading at stronger levels as the market was fearful that the military operations in the Middle East would escalate further after the U.S. struck the nuclear sites in Iran. The market was nervous to see how Iran would retaliate. We obviously saw that retaliation.
It was largely symbolic, and very quickly after those kind of retaliatory attacks, we did see the U.S. reach a ceasefire agreement with Iran and Israel, which helped to bring an end to the military conflict there in the Middle East. So for markets, that's had a clear impact in terms of it has reduced demand for the dollar. We did see dollar demand picking up in the previous two weeks as those Middle East tensions escalated, but with the conflict now hopefully finished, that does leave the dollar vulnerable to further weakness, and we have seen that kind of dollar weakening trend, which has been in place for most of this year.
That weakening trend has quickly resumed, and like you said, that has seen the dollar fall to fresh year-to-date lows. Okay, so have there been any other factors which are encouraging a weaker dollar heading into next week? Yeah, I think the other kind of focus this week alongside the easing of geopolitical tensions has been recent developments with regards to the outlook for Fed policy.
We have had a number of kind of high profile Fed governors, Christopher Waller and Michelle Bowman. Both of those have indicated that they could be willing to support a rate cut as soon as at the next meeting in July. We still think they're in the dovish minority on the FOMC, so if we look back at the voting patterns from the last FOMC meeting, we can see it was very, very divided.
We don't think that recent developments, even though Middle East tensions have eased, we don't think that on its own would be sufficient to get a majority to vote in favor of a rate cut as soon as next month. But the fact that those governors are highlighting that it is a possibility does still kind of indicate and remind the market that it's definitely not a done deal that they won't cut rates in July. We'll see for that to happen.
We need to see some more other important steps as well. Obviously next week's Herald's report is going to get even more focused, so we're looking for further evidence there that the labor market is softening in response to this trade policy uncertainty in the U.S., and certainly a lot of the kind of leading indicators, including continuing claims over the past week, have pointed towards a further loss of momentum in the U.S. labor market. So if we were to see a very weak Herald's report next week, maybe employment growth falling well below 100,000, the unemployment rate jumping, that could be enough just to push the Fed in favor of cutting rates in July rather than waiting until September.
So I think the market is, certainly in the FX market, that could be contributing to some dollar selling ahead of next week, some kind of pre-positioning there for the risk of a softer payroll report. On top of that as well, we also had a report from the Wall Street Journal suggesting that President Trump is considering announcing a replacement for Chair Powell ahead of his term ending in May of next year. Obviously, normally that would happen kind of closer to the point when his term is coming to an end, but with the report suggesting this time that it could come well ahead of that point, even as early as this summer, that potentially could be seen as a way for by President Trump to try to further kind of undermine confidence in the decision making of Chair Powell while he's still in charge of the Fed.
So from an FX perspective, we do think that is or remains a kind of downside risk for the dollar. Obviously, Trump continues to call for the Fed to be more active in terms of cutting rates and he continues to take kind of steps to try to undermine confidence in Fed policy making. That would be definitely a downside risk for the dollar.
We do think ultimately, though, that the Fed does want to cut rates. It's just waiting to see that inflation doesn't pick up maybe as much as they fear over the summer in response to the tariffs. See if inflation doesn't pick up, then you say they will have room to keep lowering rates down closer to 3% in our view.
So either way, we think that the risks are that the dollar will weaken further as we go through through the second half of this year. Having said that, though, we haven't all the news hasn't been bad for the dollar. We did have some positive news towards the end of this week that it looks like Treasury Secretary Scott Besant has suggested now that they should drop Section 899 of the budget.
That relates to the legislation now, which would allow the government to put in place higher taxes on income, investment income earned by foreigners on U.S. asset holdings. So the fact that this is going to be taken off the table, that should be seen as a comforting development for foreign investors into the U.S., and that does take a downside risk off the table going forward for the dollar. So I think that's certainly some good news towards the end of this week, even though as we speak, the dollar is obviously still trading at year to date lows.
And with that, Abdullahad, I know you have been as well looking into momentum in the FX market, and it would be interesting to hear your kind of latest thoughts on terms of what's happening in terms of momentum and whether you think that will lead to some further dollar weakness going forward. Yeah, thanks, Lee. Yeah, so this week we revisited our FX momentum strategies across the G10 majors, which have in recent periods produced consistent returns.
So the recent CFTC data and institutional flow reports have suggested that traders are cautiously adjusting their exposures in anticipation of upcoming economic data releases and central bank speculation. So this recalibration is creating a directional bias where positioning has become distinctly one-sided. We also note as we move into summer months, liquidity typically begins to thin.
While this can heighten volatility and amplify price movements, it also tends to make existing trends more pronounced. So for momentum-based strategies, this environment presents an opportunity for enhanced returns where risk is appropriately managed. So our momentum signal is calculated from historical weekly return data across a range of short-term, medium-term windows.
The goal is to capture the strength and direction of recent price trends while ensuring comparability across the G10 basket. So considering EURUSD, CABLE and USDYEN, EURUSD and CABLE are both flashing strong momentum signals comfortably above our threshold for a buy opportunity, and USDYEN is a bit of a mixed bag. While the signal is positive, it's not quite convincingly enough for us to act decisively.
And for a more detailed view on the model's performance, please check out our latest FX Weekly publication, where we'll include a methodology alongside a full bank test and some performance metrics. Great, thanks Abdullahad, and to all our listeners, thanks for listening, and have a good week ahead. Thank you for listening to this MUFG Global Markets podcast.
Rate, review and subscribe. Contact your MUFG sales rep for more information. Come back next week for more insights from the Global Markets Research Team.
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