Optimism over quicker end to Middle East conflict weighs on USD

USD: President Trump moves to de-escalate Middle East conflict

The US dollar has continued to trade at weaker levels overnight after yesterday’s sharp sell-off triggered by the de-escalation of the Middle East conflict. The dollar index once again failed to break above resistance at the 100.00-level and dropped back to a low yesterday at 98.880. The biggest mover was the price of oil with Brent briefly falling back below USD100/barrel from a high yesterday of USD114.43. The sharply lower price of oil weighed most heavily on the Norwegian krone giving back all of its gains recorded since the Middle East conflict started against the euro. The abrupt reversal was triggered by the social media post from President Trump stating that he had postponed his threat to strike Iran’s energy infrastructure after what he called “productive conversations” with the country. He told reporters that special envoys Steve Witkoff and Jared Kushner has discussions with a “top person” on the Iranian side, and claimed both sides were keen to “make a deal”. Axios has since reported that Witkoff was negotiating with Parliament Speaker Mohammad-Bagher Ghalibaf. However, he has denied that negotiations have taken place on social media. Iranian state TV have also reported that the US sought talks through intermediaries, but Tehran has not responded.

At the same time it has been reported that a US delegation is arriving in Pakistan “in a day or two” for possible talks to end the conflict according to sources in Islamabad’s Foreign Ministry. However, Pakistani sources said that Tehran is “still not ready” to hold talks with Washington due to mistrust. Efforts are reportedly underway through back-channel diplomacy to persuade Iran to come to the negotiations with Pakistan, Turkey and Egypt “jointly facilitating the effort”. Pakistan’s Prime Minister Shehbaz Sharif has reportedly spoken with Iranian President Masoud Pezeshkian in an “attempt to court Tehran”. The US delegation set to arrive in Pakistan is likely to include Steve Witkoff and Jared Kushner.

President Trump’s decision to step back from striking energy infrastructure in Iran for at least five days to allow for negotiations with Iran, has helped to reduce the immediate risk of further damage to energy sites in the Middle East. Iran had threatened to retaliate by launching further attacks on energy sites in the Middle East. However, it remains highly uncertain if the talks will prove successful and bring a quicker end to the conflict. For financial markets what matters most is whether energy supply is able to normalize through the Start of Hormuz. It currently remains effectively closed which if not resolved in the coming weeks and months could deliver an even bigger negative energy price shock for the global economy. We continue to hope that the risk of a bigger energy price spike will keep pressure on all parties to continue to de-escalate. While the conflict and energy supply disruption continues, foreign exchange markets are likely to remain volatile. The pick-up in volatility has been has greater  for emerging market currencies than for G10. JPMorgan’s measure of one-month EM FX volatility has risen to the highest levels since last April following President Trump’s “Liberation Day” tariff announcements while G10 FX volatility is still well below levels from last April.

VOLATILITY HAS PICKED UP MORE FOR EM CURRENCIES

Source: Bloomberg, Macrobond & MUFG GMR

EUR: PMI surveys to reveal initial hit to business confidence in Europe

The euro has been one of the main beneficiaries from the de-escalation of Middle East tensions alongside the yen and pound. It has helped to lift EUR/USD back above the 1.1600 level, and move further above the low point from the middle this month at 1.1411. The improvement in investor sentiment towards the euro will be tested today by the releases of the latest PMI surveys for March. The surveys are expected to reveal the scale of the initial negative hit to business confidence in the region from the energy price shock triggered by the Middle East conflict. The price of natural gas in Europe has jumped higher by around 80% since the conflict began and is trading at the highest level since the start of last year. In comparison to the Ukraine conflict triggered energy price shock in 2022, the scale of the increase in natural gas prices in Europe remains relatively more modest when they increased by almost four times at the worst point in August 2022. Evidence of a negative hit to business confidence in the region today could put a further dampener on market expectations for more aggressive ECB rate hikes.  The euro-zone rate market had moved to price in 3-4 ECB rate hikes for this year prior to the climbdown yesterday from President Trump’s which was starting to look more like a potential overshoot.      

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com