FX Daily: Muted Reaction To Re-Escalation In The Gulf

The more serious exchange of fire in the Gulf and the jump in oil yesterday have seen far less of a reaction in FX than in the rates space. However, Brent closer to $80/bl than $70/bl stands to delay any disinflation trends and increase the risk of a Fed hike. Expect the dollar to remain bid versus the low-yielders, while the Korean won might outperform

USD: Higher energy prices will fuel the Fed hawks

Dominating global markets yesterday was the seeming breakdown in negotiations between the US and Iran and a more serious exchange of fire. That has extended overnight, with the US military striking infrastructure targets in northern Iraq – the first strike on infrastructure since early April. Brent briefly touched $80/bl and we saw some large moves at the short end of interest curves. This follows the playbook from early March. The FX reaction was more muted, where the dollar was a little stronger, but the biggest impact was a jump in volatility and the unwinding of carry trade positions in the EM high-yielders. This especially hit extended positions in the Hungarian forint – see below.

In addition, last night saw the release of the FOMC minutes for the June meeting. Some had feared that Fed Chair Kevin Warsh's new non-communications strategy would gut these minutes. That was not the case. Our key takeaway is that those at the meeting were presented with two scenarios – a delayed cut in rates should inflation dissipate, or a more immediate hike if inflation remains high. Both of those scenarios were seen as equally credible. The dollar and US rates did not move much on the minutes, and it will probably be next week when we get a better steer on the Fed. Here, we have the June CPI figure next Tuesday and Kevin Warsh's testimony to the House on Wednesday. Today at 15CET we will also hear from the New York Fed's John Williams. He's from the dovish end of the spectrum.

Our bias is that higher energy prices will provide fuel for the Fed hawks and keep the dollar supported on dips – particularly against the low yielders. High-yielding currencies can enjoy better insulation against the stronger dollar given the summer months and investors' tendency to jump into carry trade positions on any sell-off. DXY is trading around 101.00 and we favour it back to the 101.50 area.

EUR: Greenland seems a distraction

EUR/USD has held up remarkably well given the jump in oil prices yesterday. Yield spreads did narrow in favour of the euro, where euro swap rates rose around 7-8bp more than short-dated US rates on the view that the ECB is more likely to pull the trigger on another hike in September. However, we think the Fed story will be a more dominant theme and can easily see EUR/USD handing back early gains today and sending the euro back below the 1.14 level.

Could some of the EUR/USD resilience be down to President Trump mentioning Greenland again at the NATO conference? Remember that his threats back in January sparked a backlash against US asset markets from European investors. This link looks tenuous at best.

On the eurozone calendar today is the release of the ECB minutes for the 11 June meeting. We assume this will be pitched as hawkish and, combined with higher energy prices, keep expectations alive for a follow-up hike at the September meeting. That is currently priced at +22bp by money markets.

Elsewhere, sterling continues to do well. This repeats the performance at the start of the Gulf crisis in early March. Here, the front-end of the sterling money market curve adjusts more than in the eurozone and EUR/GBP goes offered. And the Swiss franc underperforms in a higher rate environment on the view that the Swiss National Bank will be the last of the G10 central banks to hike. This is helping to turn the GBP/CHF long-term bear trend and 1.10 could be the next stop here if energy prices stay high.

CEE: Forint long position is being tested

The meeting of the National Bank of Poland did not bring many surprises. The statement is broadly neutral and almost unchanged from June. The MPC acknowledges lower oil prices, weaker growth in Poland’s key trading partners, and a recent decline in inflation. At the same time, it stresses that uncertainty is still elevated, particularly due to tensions in the Middle East. The new CPI projection came in above our expectations, including for 2027. That said, the NBP may be assuming higher oil prices than current market levels. The focus will be on President Adam Glapinski's press conference today. However, the global picture is again clouding the outlook and the best expectation for now is no change in NBP rates for a longer period of time.

Yesterday, the CEE region was hit hard by US-Iran headlines, and we saw a sell-off across rates and FX. In the Czech Republic, the market added half a rate hike to pricing for a total of one and a half hikes now. In Poland, expectations have returned from a 50% probability of a rate cut to stable rates for a longer period.

In the FX space, we saw the biggest move in EUR/HUF with a 1.2% move up, the biggest upside move since early March at the start of the conflict. Of course, the forint is extremely vulnerable due to the massive long positioning built up after the general election in April, and at the same time, the central bank indicated a series of rate cuts at the June meeting, being the only outlier in the region. We believe that levels around 360 ​​EUR/HUF will be attractive for the market for new forint longs if the geopolitical situation proves to be temporary and we see a return below 356 again.

KRW: Some reprieve for the won

USD/KRW remains the most volatile Asian FX pair and trades on one-week volatility near 13% – way above anything seen in the G10 space. That volatility stems from the heavy concentration of the tech sector in Korea's Kospi benchmark equity index. That tech sector might actually help the won in the short term. One of Korea's largest chipmakers, SK Hynix, has just closed an American Depositary Receipt (ADR) listing to raise around $25bn. Some of those funds are expected to find their way back into the won after the ADR's settlement on 16 July.

At the same time, the Bank of Korea has turned hawkish after upgrading its growth and inflation forecasts in May. A 25bp rate hike to 2.75% is widely expected at next week's meeting. While it is hard to call USD/KRW lower, given the current rise in energy prices, we think there might be a short-term window for further gains in KRW/JPY. This has already done well over the last four sessions and could have a window to the 11.00 area, before the possible arrival of more Japanese FX intervention in USD/JPY next Thursday/Friday – ahead of Japan's Marine Day holiday on 20 July.