USD rebounds as fears over energy supply disruption intensify

USD: Strait of Hormuz threats add to concerns over energy supply disruption

The US dollar has strengthened overnight resulting in the dollar index rising back closer to the 100.00-level after last week’s correction lower. The US dollar initially strengthened at the start of the Middle East conflict but failed to extend its advance over the past week. The US dollar’s upward momentum over the past week was dampened in part by the hawkish repricing of rate hike expectations outside of the US. European rate market have moved to price in multiple rate hikes from the BoE (click here) and ECB (click here) after their latest policy updates. Market participants expect European central banks to tighten policy in response to the energy price shock more than the Fed contributing to yield spreads moving against the US dollar. However, even the US rate market is now starting to anticipate rate hikes from the Fed as well. There are currently around 15bps of Fed hikes priced in by year end which compares to around 80bps for the BoE and ECB. We remain unconvinced that yield spreads will be the main driver of FX performance if the energy price shock continues to intensify, and still expect the US dollar strengthen as economies outside of the US in Asia and Europe will be hit harder as stagflation risks continue to build.   

Developments over the weekend have added to concerns over a more disruptive outcome for the global economy as the Middle East conflict moves into the fourth week. President Trump has given Iran a two-day deadline to reopen the Strait of Hormuz or face having it power plants bombed. The exact deadline is today at 7.44 p.m. New York time. However, the threat appears unlikely to work. Iran has warned that if their power facilities are attached, it could close the Start of Hormuz “completely". The Iranian military has also threatened to target “all energy, information technology, and desalination infrastructure” linked to the US and Israel in the region. Adding that the headquarters and assets of financial entities that buy US Treasury bonds are “legitimate targets”. The latest rhetoric highlights that neither side is willing to back down, and that there is a significant risk of further disruption to energy supplies in the region that could prove to be more permanent. It came a day after comments from President Trump stating that he considering “winding down” military operations.

Overall, the latest developments have contributed to risk off trading at the start of this week. The G10 commodity currencies including the Australian dollar have underperformed overnight as the US dollar has rebounded. At the same time, the price of precious metals including gold and silver have continued to correct sharply lower. The price of gold has lost almost a quarter of its value since the Middle East conflict began, and has fallen back towards support from its 200-day moving average at around USD 4,090/ounze. Position liquidation and the hawkish repricing of central bank rate expectations have weighed on precious metal prices. The price of gold has failed to benefit so far from heightened geopolitical risks and stagflation fears. 

USD HAS DIVERGED FROM YIELD SPREADS DURING ENERGY PRICE SHOCK

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Verbal intervention & BoJ hike speculation helping to dampen weakness

The yen has held up better than most other G10 currencies against the US dollar overnight with USD/JPY continuing to trade just below the 160.00-level. The yen has been supported by further verbal intervention from Japanese policymakers. Vice Finance Minister for International Affairs Atsushi Mimura warned that the government will take all possible steps to respond to speculative moves in the market as needed. He noted that “some market participants say speculative moves in crude oil futures are affecting the foreign exchange market”, and “considering the impact of currency moves on the economy and people’s daily lives, the government will take all possible measures at any time”.  He added that they are ready to act “on all fronts”. The comments will keep market participants wary of the risk of direct intervention to support the yen if USD/JPY breaks above the 160.00-level and moved back closer to the high of 161.95 from July 2024.

The weak yen and rising energy prices encouraged to the BoJ to leave the door open to a rate hike as soon as at next month’s policy meeting. There are currently around 16bps of BoJ hikes priced in by the April policy meeting. The case for another BoJ hike has been supported as well by further evidence of stronger wage growth in Japan. Japan’s largest labour union, Rengo, revealed that its workers secured an average pay increase of 5.26% which was only slightly lower than last year’s initial reading of 5.46%. The base pay component was slightly higher than last year at 3.85%. It was the third consecutive year that workers had secured wage increases of over 5%.           

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com