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.
What the desk is arguing
The macro backdrop of rising military tensions in the Middle East could provide support for the USD, reversing its recent downtrend. As the currency approaches its year-to-date lows, traders may seek shelter in the safer haven assets, with the dollar typically benefitting from such shifts during geopolitical unrest.
Furthermore, the timing coincides with the upcoming FOMC meeting, where any indications of tightening monetary policy could boost the USD. Analysts note that historical patterns suggest that increased conflict often results in heightened demand for the dollar, challenging the notion that recent trends of weakness are sustained and may instead offer an opportunity for a reversal.
Where it sits in our coverage
In line with our consensus target of 1.075, analysts believe a turn in USD strength may present opportunities for positioning against this trend. Current expectations reflect a broader currency range between 1.04 and 1.12, indicating that while the dollar may experience upward momentum, volatility around economic data and geopolitical developments remains high.
Recent targets from notable firms include: - JPMorgan, with a Mar-26 target set at 1.10 - Barclays, aiming for a target of 1.08 by the same tenor - BofA, setting a more conservative target of 1.04, reflecting a cautious stance.
How other firms see it
Market sentiment is mixed, as some firms echo the belief that geopolitical factors will support the dollar. Goldman Sachs has expressed a similar view, aligning with MUFG's outlook on dollar strength amid uncertainty.
Conversely, BofA presents a contrary perspective, forecasting further dollar weakness with a target of 1.04 due to anticipated dovish signals from the Fed. Other firms like Citi may also diverge on this narrative, emphasizing economic fundamentals over geopolitical concerns.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01Escalating military conflicts may support a reversal in USD weakness.
- 02The approaching FOMC meeting heightens the potential for dollar strength.
- 03Market sentiment is split, with some firms aligning with the bullish outlook on the USD while others expect further weakness.
Market implications
If the USD strengthens in the wake of rising tensions, expect increased volatility across currency pairs, notably those against safe-haven counterparts like the JPY and CHF. This could lead to repositioning opportunities for traders as they anticipate Fed responses to unfolding events.
Risks to this view
The primary risk remains the potential for diplomatic resolutions that may lessen geopolitical tensions, which could deflate any sudden demand for the USD. Additionally, if the FOMC signals a more accommodative stance, this could challenge any narrative of dollar strength.
Welcome to the MUFG Global Markets FX Week Ahead podcast with Lee Hardman, Senior Currency Analyst at MUFG. It's Friday, the 13th of May, 2025, and joining Lee to pose some questions on the financial market themes for the week ahead is Seiko Katauka-Fisher, Head of Japanese Client FX Sales. 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 Seiko.
It's been another volatile week in the FX market. What has caught your attention over the past week? Yeah, a couple of things.
Obviously, the dollar weakening trend was in place for most of the past week with the dollar falling to fresh year-to-date lows yesterday on the back of further evidence of the U.S. economy softening in response to the protectionist trade policies of President Trump and the policy uncertainty remaining so high as obviously having a negative impact on the U.S. economy. We saw in the latest initial and continuing claims data that does point towards further softening of the labor market, which if that continues will open the door for the Fed to cut rates again later this year. And at the same time this week, we also saw clearer evidence as well that inflation in the U.S. is continuing to slow at the start of this year.
If you look at sort of core measures of inflation, those have been kind of roughly kind of flatlining over the last kind of two to three months, which is certainly better than maybe the Fed would have anticipated at the start of this year. And certainly, if it wasn't for the fact that President Trump has put in place these higher tariffs and created all of this uncertainty, Fed potentially would be in a position next week to start cutting rates. We don't think that will be the case.
Obviously now with the uncertainty, the Fed still wants to see what happens before they're willing to cut rates. But yeah, it does create more room further down the line for the Fed to cut rates. And I think that that's contributing to the weakness in the dollar that we're continuing to see this week.
Having said that though, obviously today we have seen the dollar bouncing back alongside other safe haven currencies like the Swiss franc and yen, that that's obviously in response to the military strikes from Israel on Iran overnight, that has triggered at least initially a kind of flight to quality bid in the market, boosting those traditional kind of safe haven currencies. On the other hand, investors have obviously decided to take some kind of risk off the table going into the weekend, given we don't know if the situation will escalate further in the coming days. It certainly sounds like that could be the case based on the rhetoric from officials in Israel and Iran.
So for the FX market, that has triggered a liquidation of some of the kind of carry trade positions that have been built up recently, particularly some of the emerging market high yielding currencies have been hit harder, such as the South African Rand, Mexican Peso and the Hungarian Forint. There's a busy schedule of central bank updates in a week ahead, including the Fed, Bank of Japan, BOE and S&B. What are you expecting?
Yeah, like you said, it's a busy schedule of central bank meetings upcoming next week. In light of obviously the military developments and geopolitical risk increasing in the Middle East, that just adds to the uncertainty for central banks over the outlook. So from a simple point from that alone, it would suggest more caution from central banks, which would kind of fit with our view and the market's view that most of those central banks are going to leave policy and chain next week, including the Fed.
Like we said before, we think the Fed is comfortable to keep rates on hold for now and that we think really that the earliest point that they'll potentially cut rates is September. You can't completely rule out July, but I think for that to happen, you need to see a particularly bad period report at the start of next month. The main kind of central bank to start the week in terms of kicking off proceedings will be the Bank of Japan.
As we know, they've already expressed more caution recently about hiking rates further because of the trade policy uncertainty. So really the focus next week is going to be more about what they do in terms of their tapering plan. The expectation has been building in the market that they will slow down the pace of tapering from the upcoming fiscal year from April 2026 going forward.
That to us looks like a highly plausible scenario. Obviously if they were to slow that pace of tapering down, that could be seen as a shift, at least initially by the market, which could already be encouraging yen weakness despite the pickup that we've seen in safe haven demand for the yen at the end of this week. The other central banks, obviously the Bank of England, I think for the Bank of England, we're expecting them to kind of acknowledge the recent soft labor market data that we've seen from the UK pointing towards the weakness there in the labor market, which we think should give the Bank of England more confidence that they can continue with the current quarterly pace of rate cuts.
So we're more confident again now that they'll cut rates again in August, as we've seen this week that that weaker labor market data and also the bigger than expected kind of payback weakness in GDP data in April after the very strong growth we saw in Q1, that has certainly contributed to the pound underperforming this week, helping to lift euro sterling to fresh highs. And then finally, the other kind of central bank that we think could be more of a market movement next week would be the Swiss National Bank. The expectation is that they will lower their policy rate back to the zero bound, given inflation continues to significantly undershoot their target falling into negative territory again in the latest months.
So pressure will certainly be on the Swiss National Bank to keep easing policy going forward. And while they can't completely rule out that they could deliver a bigger rate cut and bring rates into negative territory, we think at this stage it's probably a bit too early to anticipate that they would go down the negative rate route at this point in time. So for us, the market's probably going to be watching more closely to see whether the S&P leader indicates that they're open to negative rates and maybe one of the following meetings in the second half of this year, see if we were to get that kind of indication that could trigger some weaknesses in the Swiss franc next week, obviously depending on whether the tensions in the Middle East escalate.
Obviously, if they were to escalate significantly, that would put further upward pressure on the franc. Thank you very much, Lee. Thank you.
Thank you for listening to this MUFG Global Markets podcast. Rate, review and subscribe and 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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