DXY-weighted short-term implied volatility has continued to fall, now at 2021 levels, ignoring geopolitical and rate dynamics. The main reason could be the overall contained response to this spring’s events. Risks are definitely of a pick-up in volatility from now on, and of short-term USD gains. The GBP rally has stalled; we expect more EUR/GBP upside.
USD: Low vols carry risks
DXY-weighted one-month implied volatility has broken below the 5.50 area that marked the January, May and June lows. Excluding the Christmas 2025 dip, it is now at its lowest level since 2021.
That is remarkable given the serious military re-escalation between the US and Iran and the prospect of a new Federal Reserve tightening cycle. The explanation goes beyond the muted energy-market response to the July Gulf headlines. We suspect it primarily reflects how well contained volatility remained between March and May despite sizeable moves in both rates and commodity prices. Incidentally, AI-fuelled equity resilience still appears to be anchoring currencies and helping sustain a self-reinforcing low-volatility, carry-trade environment.
At this stage, risks are clearly skewed to the upside for both FX volatility and the dollar. The longer oil prices only partially price a new supply shock, the greater the risk of non-linear rallies. But there is also a realistic path towards Middle East de-escalation, lower oil prices and more dovish flexibility at the front end of the USD curve. That would ultimately point to a weaker dollar across the board. This remains our baseline for after the summer, although we acknowledge that the near-term backdrop looks far less supportive for USD bears.
Today’s US calendar includes University of Michigan surveys, industrial production and housing starts. We will also hear from Fed dove Philip Jefferson after yesterday’s unsurprisingly hawkish remarks from Lorie Logan and Jeffrey Schmid.
EUR: Stuck rangebound for now
Our macro team has published their preview of next week’s European Central Bank meeting. We expect a consensus hold, but rising oil prices have reopened the door to a surprise hike. Higher energy costs have pushed the macro backdrop back towards the ECB’s June baseline scenario, which assumed at least two rate hikes.
While softer inflation data argues for patience, some hawks may favour another “insurance” hike to reinforce the ECB’s inflation-fighting credibility. Our base case remains a September move, but next week’s meeting could still deliver one final hawk-dove showdown before the summer break.
Barring surprising revisions in the eurozone’s June CPI, markets’ headline fatigue can keep EUR/USD hovering around the 1.420/1.460 area today. For the moment, there appears to be little in place to drive either a break above 1.150 or a retest of sub-1.135 levels.
GBP: More room to give back gains
EUR/GBP has rebounded after an extended run of an important break lower. Still, at 0.850, it remains around 1.5% undervalued according to our short-term fair value model.
As discussed recently, positioning adjustments and carry trade attractiveness likely played an important role in driving GBP strength. But approaching a change in government (Andy Burnham becomes UK Prime Minister next week) with short-term overvaluation is a risk for the pound. Watch for headlines about Burnham today, as he’s scheduled to make a big speech.
Incidentally, we still see plenty of downside risk for front-end GBP rates. Market pricing for 35bp of tightening by year-end looks way too aggressive. Our call remains a hold. We still expect a return to 0.870 in EUR/GBP by the end of the summer.
CEE: Surprising sell-off bringing new opportunities
After two days of relief in Central and Eastern Europe, markets moved back into risk-off mode yesterday, contrary to our expectations, with a broad sell-off across asset classes. Elevated oil prices and higher core rates pushed CEE rates higher, with a steepening bias. Markets slightly increased the implied probability of Czech National Bank rate cuts, now pricing almost two hikes. In Poland, rate cut expectations for this year fell to around 20%, while in Hungary the expected easing cycle has been scaled back from 150bp a few days ago to 120bp.
Hungarian assets are facing the heaviest selling pressure within the whole EM space over the last several days, which we attribute to crowded long positioning and a broadly bullish market view since the April general elections. Yesterday’s move likely reflected some profit-taking and risk reduction amid global uncertainty. However, we do not think the underlying story has changed much: both rates and FX remain attractive, particularly after the sell-off and improved entry levels.
We continue to see value at the front end of the curve, further steepening and the currency, while the recent sell-off appears to have been overdone. EUR/HUF stabilised above 361, its highest level since mid-May and close to post-election levels. We still see 350-360 as the most likely EUR/HUF range for the rest of the year.
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