FX Impact Limited From Crude Collapse Ahead Of FOMC

So far this week, the dollar has largely ignored the sharp decline in oil prices, suggesting the FX markets had already largely discounted the deal. After opening the week with a gap down, the greenback has since been recovering and eventually returning to levels seen before the weekend. The lack of a more meaningful move in FX suggests that investors remain focused on the underlying support coming from US economic data and Federal Reserve expectations rather than just developments in the energy market. 

Still, the EUR USD exchange rate could now be heading higher, so long as there are no further disruptions to oil supply from the Strait of Hormuz. Attention will be on the FOMC meeting and new Chairman Kevin Warsh tonight. 

Crude oil drop should support euro

With expectations of Iranian oil coming back online, with prior disruptions having been partially offset by historic releases of oil reserves and increased output elsewhere (e.g., Venezuela), markets are betting on a quick return to normalcy in the oil markets. Accordingly, oil prices have extended the the drop for the fifth consecutive day. 

Further falls in oil should be good news for the euro and other currencies where the economy relies on energy imports, all else being equal. Thus, if crude continues to retreat, currencies such as the euro and sterling could find support after recent weakness. The EUR/USD has already shown signs of stabilisation as traders position themselves ahead of this evening’s key event on the US economic calendar – the FOMC meeting. 

Central banks in focus

Meanwhile, among the major events on the calendar, tonight’s Federal Reserve decision is increasingly shaping up as the most important catalyst for foreign exchange markets. We have already heard from two central banks this week. The Bank of Japan delivered a widely anticipated rate increase, although the move has so far failed to lift the yen, while the Reserve Bank’s attempt to maintain a hawkish tone failed to convince investors.

The FX market’s response since the announcement of the US-Iran agreement has been a little surprising, suggesting that the dollar enjoys firmer foundations than it did when the war first started. Despite a substantial fall in oil prices, most of the greenback’s initial losses were reversed, underlining a shift in market priorities away from crude and back towards monetary policy.

That said, some softness in the dollar has since emerged here and there, hinting that lower energy prices may still be filtering through to currency markets with a delay. Nevertheless, the broader narrative remains centred on central bank policy and economic data rather than just geopolitical risk and commodity prices, which dominated trading during the early stages of the Middle East conflict.

This places the FOMC meeting firmly at the centre of attention. For the dollar to extend its recent resilience, policymakers may need to reinforce the view that additional tightening remains on the table. Markets appear to be demanding stronger signals before rewarding hawkish rhetoric. Unless the Fed is hawkish, I am now expecting the greenback to take a tumble and that could benefit currencies that were previously hurt by oil’s upsurge. 

EUR/USD stabilising

For the euro, attention today will also remain on developments surrounding the US-Iran Memorandum of Understanding ahead of its expected signing later this week. President Trump has expressed confidence that shipping through the Strait of Hormuz could normalise quickly, although logistical challenges, including de-mining operations, may delay the process. But oil investors remain optimistic, as currently implied by lower oil prices.

The EUR/USD fell back to levels seen before the weekend, before bouncing back again. The recent energy spike is likely to have dampened growth in the Eurozone, which may be revealed in upcoming data releases. This helps explain why investors remain reluctant to establish aggressive bullish euro positions just yet. 

In my view, however, the downside risks for EUR/USD have shrunk significantly, albeit not disappeared entirely. Any renewed concerns regarding the implementation of the US-Iran agreement or delays to the reopening of Hormuz shipping routes could hold back the single currency. But it will take a lot of effort to push the EUR/USD back below the 1.1500 level.

I think the path of least resistance is now to the upside again and accordingly, I expect rates to break above the 1.1600-1.1625 resistance area unless the Fed is super hawkish. This would constitute a bullish technical development. Still, there are more potential resistance levels ahead, including around the 1.1670-1.1700 zone where a bearish trend line and the 200-day average meet with prior support and resistance area. Bullish if we go above that zone.