FX Weekly

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Breakdown of talks keeps risks elevated

FX View:

The FX fallout from the failure of the peace talks in Pakistan over the weekend has been modest. Crude oil prices are around 8% higher but broader risks conditions have not deteriorated markedly. How effective will the US blockade of the Strait of Hormuz be and how will Iran respond to that? There certainly appears to be a high risk of re-escalation of the conflict or at the very least a fragile ceasefire continuing but under a more severe supply disruption assuming the US blockade means the Iranian endorsed tankers also fail to get through while other ships continue to refrain from attempts to pass through. While the general FX moves have been subdued we should not assume that will continue and the longer the energy supply crunch drags on, the greater the economic impact will be and at some point global equity markets are likely to respond. So renewed US dollar appreciation remains the risk this week if conditions worsen further.

USD BROAD-BASED SELL-OFF LAST WEEK ON PEACE HOPES

Source: Bloomberg, close on 10th April 2026 (Weekly % Change vs. USD)

Trade Ideas:

We are maintaining our short EUR/USD and GBP/CHF trade recommendations.

JPY Flows: 

The monthly portfolio investor flows, by Japanese investor type highlighted a record sale of foreign bonds over Feb-Mar combined.

G10 Price Action - Oil Volatility Compression Signal:

Filtering historical G10 FX returns on periods of declining oil volatility reveals a clear skew towards positive FX returns (ccy vs. USD) relative to the unconditional sample. This is significant for EUR, GBP and AUD.

FX Views

USD: Updating our Middle East conflict scenarios

The negotiations over the weekend have not resulted in any definitive peace deal and that will remain a considerable challenge over the coming weeks and indeed over a longer timeframe of months. But for the financial markets the maintenance of the ceasefire for now is at least containing the initial reaction to the failure in reaching a peace deal. The market reaction also reflects the low expectations of a break-through with market moves we believe all within the range of expectations. The 7%-8% rebound in crude oil prices is reasonably modest considering but the planned US blockade of the Strait of Hormuz was not expected and hence reinforces the risks of a further deterioration in sentiment as the week unfolds. It remains clear how the blockade will operate and how effective it will be. If it stops the modest flow of tankers over recent weeks then the supply disruption will be more severe. The backdrop is certainly not conducive to increased tanker traffic and there are high risks that we will soon return to escalated military conflict. Jet fuel shortages across Europe are being increasingly reported and the situation is set to deteriorate over the coming two-to-three weeks. Flight disruptions and risks of panic buying of fuel could have a meaningful impact on economic conditions that could challenge the ongoing resilience in equity markets.

Three scenarios were laid out in the earlier part of the conflict were published in an earlier FX Weekly (here) and the crude oil price that has traded around the USD 100pbl, in a rough range of USD 110-90pbl since 12^th March is consistent with our original Scenario 2. Our original best-case Scenario 1 (quick de-escalation and crude back to USD 75-80pbl) is long gone and really going forward we now see two plausible scenarios. An updated Scenario 1 would see the current ceasefire hold with no clear re-escalation back into intense conflict. In this scenario the Strait of Hormuz would gradually see tanker traffic volumes pick up but with uncertainties high crude oil prices remain elevated throughout this quarter, roughly in the current range before starting to retrace lower in the Q3 and Q4 on an assumption of some sort of resolution by then. One key difference in our assumption going forward this time is that the retracement in crude oil prices takes longer and we do not retrace back to the pre-conflict level of around USD 70pbl. Production facilities in the Middle East have been damaged and the regime in Iran looks set to remain in power and hence we must assume a less favourable outlook for the return of pre-conflict energy supply.

Similarly our update Scenario 2 mirrors the old Scenario 3 worst case scenario and this incorporates the re-escalation of military conflict on the failure of the current ceasefire holding. The Strait of Hormuz remains closed and both the US-Israel and Iran increase attacks on energy production and storage facilities and investors again consider a more severe energy supply disruption. In this scenario the price of Brent crude oil breaks higher and above the USD 120 p/bl level for the first time. A new higher range USD 120-160pbl emerges which was wider reverberations for financial markets. In particular there is a clear increase in expectations of recessionary conditions that results in much bigger global equity market declines. In this scenario crude oil prices stay higher for longer but the demand destruction that follows results in a sharp decline in energy prices reflecting the impact from weaker growth and demand destruction.

USD NOW UNDERPERFORMING VS RUSSIA/UKRAINE

Source: Bloomberg, Macrobond & MUFG GMR

POSITIVE VIX/USD CORRELATION CONTINUES

Source: Bloomberg, Macrobond & MUFG GMR

In Scenario 1, which is broadly our assumption and aligns closely if not exactly (some FX forecast tweaks may be required) with our current FX forecasts we see the ECB hiking on two occasions – we initially assumed April and June but the timing could easily be June and July but over the next three meetings we would expect to see two 25bp hikes. For the BoE we expect one 25bp hike in June under Scenario 1. The current OIS pricing indicates 40bps of hikes by the ECB priced by July and 55bps by year-end while for the BoE 16bps is priced by June but a 25bp hike is fully priced by July. We continue to believe that the tolerance for “looking through” this energy price shock will be much lower than in the past. We would also argue the rhetoric from the ECB in particular is consistent with our view. Under our more severe scenario, a very quick, sharp and notable equity market drop (-20% or more in days or weeks) could prompt a delay from central banks hiking but once conditions stabilised the ECB and BoE could still see the need for getting ahead of the dangers of a renewed retrenchment of inflation due to a longer period of higher energy prices.

After of six weeks of conflict to the point of the ceasefire, it is clear that the US dollar has underperformed our expectations based on our original expected moves. Based on a 40%ish move higher in crude oil prices we would have expected to see a EUR/USD drop of 3% or so. The EUR/USD rate is currently 1.0% lower. The change in swap spreads against the dollar and the lack of risk-off trading conditions have helped contribute to that. Under our new Scenario 1 of crude remaining around current levels before slowly retracing from Q3 onwards, we would expect to see EUR/USD trade around current levels to lower before moving higher in the second half of the year. Our current Q1 2027 forecast is 1.2000 and given the more modest gains for the dollar that forecast could now be too low. The only scope for a notable gain for the dollar would be if we saw a period strong risk-off on global recession being priced that would result in a big decline in global equities of around 20%. That’s still a considerable risk and as time passes the impact of the supply disruption will become more evident. The US dollar would appreciate with high-beta G10 suffering most. The Swiss franc and yen could perform best as front-end yields in the US fall.

STRONG USD CORRELATION WITH OIL CONTINUES

Source: Bloomberg, Macrobond & MUFG GMR

USD DRAGGED WEAKER, HELPED BY YIELD SPREAD

Source: Bloomberg, Macrobond & MUFG GMR

USD: Why has the USD not strengthened more in response to energy shock?    

The USD has corrected lower over the past week, driven by a de‑escalation of the Middle East conflict following the agreement between the US and Iran on a temporary two‑week ceasefire. The USD remains at weaker levels even after negotiations between the US and Iran failed over the weekend. The main beneficiaries among G10 currencies have been the high‑beta commodity currencies of the NOK, NZD and AUD alongside the other Scandinavian currency of the SEK. All four had underperformed since the onset of the conflict, with NZD and SEK particularly hard hit, having fallen by around 5% against the USD. Similar reversal dynamics have also been evident across emerging market currencies. The HUF, ZAR, MXN and CLP have all outperformed over the past week, supported by the temporary ceasefire, after weakening more than most other EM currencies earlier in the Middle East conflict.

This leaves the USD only modestly stronger since the Middle East conflict began. At its peak, the dollar index rose by around 3.1% by the end of March, but it now stands only about 1.4% higher than prior to the onset of the conflict in late February. The USD has therefore strengthened by less than we initially expected in response to the energy price shock when we upgraded our forecasts (click here) at the end of last month. This outcome suggests that we may have been premature in dropping our earlier call for a significantly weaker USD, when we had been forecasting a further 4–5% decline over the subsequent 6–12 months (click here). The relative underperformance of the USD may reflect several factors. Firstly, investors may be increasingly optimistic that the Middle East conflict will continue to de‑escalate, paving the way for a sustainable peace agreement and a gradual resumption of energy supplies through the Strait of Hormuz. The Brent crude futures curve, for example, points to oil prices falling back below USD 80 per barrel later this year. Nonetheless, a more prolonged period of elevated energy prices than currently expected could still provide renewed support for the USD. Secondly, market participants may be underestimating the potential drag on growth outside the US, particularly in Europe and parts of Asia, which could offer more support to the dollar. By contrast, the US economy may prove more resilient than expected to the energy price shock, with downside risks to the US labour market appearing to have eased at the start of this year.

Thirdly, the USD’s strength has been constrained by diverging monetary policy expectations in response to the energy price shock. Among the major central banks, the Fed has signalled that it is the most comfortable leaving rates on hold, while still keeping the door open to further rate cuts once the inflation shock has eased and/or if the labour market weakens further. A prolonged rate pause appears to be the key message that the Fed’s main leadership is sending to markets, rather than signalling a readiness to raise rates to address near‑term upside inflation risks. New York Fed President Williams stated last week that “the story hasn’t changed very much” with respect to underlying inflation, and he expects core inflation to rise by just one or two tenths of a percentage point. As a result, he believes that monetary policy is “really well positioned” to wait and assess the economic consequences of the Middle East conflict, while retaining the flexibility to respond should conditions change. At the same time, he expressed greater confidence in the US labour market, judging it to be “more stable now” and “definitely not” an economy experiencing labour‑market weakening. These remarks are consistent with current US rate market pricing, which anticipates that the Fed will leave rates on hold this year.

G10 FX PERFORMANCE PRE & POST CEASEFIRE

Source: Bloomberg, Macrobond & MUFG GMR

PRICE OF OIL IS EXPECTED TO DROP BACK

Source: Bloomberg, Macrobond & MUFG GMR

In contrast, European rate markets continue to expect both the BoE and the ECB to respond to the energy price shock by raising rates in the coming quarters, although the timing and magnitude of tightening have been scaled back following the announcement of the two‑week ceasefire. In particular, the euro‑area rates market has pushed back expectations for the first ECB rate hike from this month to June and is now leaning more toward two hikes by the end of the year, rather than the three or even four that had previously been priced in. Our forecast for two ECB rate hikes is more consistent with the ECB’s own adverse scenario, under which inflation is projected to be 0.9 percentage points higher in 2026 and 0.1 percentage points higher in 2027 relative to the baseline. In this scenario, inflation is forecast at 3.5% in 2026 before easing to 2.1% in 2027. President Lagarde has indicated that if the shock results in a large but not overly persistent overshoot of the ECB’s inflation target, “some measured adjustment of policy could be warranted.” The slow reopening of energy supply routes through the Strait of Hormuz, alongside damage to energy production in the region, has increased the likelihood of the adverse scenario materialising, even if the two‑week ceasefire holds and ultimately leads to a more durable peace agreement.

The USD could weaken further if the ECB and BoE proceed with policy tightening while the Fed leaves rates on hold. Yield spreads have moved sharply against the USD since the Middle East conflict began. Although the USD initially strengthened on the back of the energy price shock, it has started to realign with yield spreads since the ceasefire deal was announced. If the investor concerns over the energy price shock continue to ease, it leaves the USD vulnerable to further weakness. On top of unfavourable yield spread developments, the conflict in Iran has further heightened US policy uncertainty under President Trump which could undermine confidence in the USD and reinforce selling pressures if safe haven flows continue to ease.

LOWER PEAKS FOR FX VOL SUPPORTIVE FOR CARRY

Source: Bloomberg, Macrobond & MUFG GMR

NARROWING YIELD SPREADS FAVOUR WEAKER USD

Source: Bloomberg, Macrobond & MUFG GMR

Weekly Calendar

Source: Bloomberg & MUFG GMR

Key Events:

• The main focus at the start of next week is on the fallout from negotiations over the weekend between the US and Iran that failed to reach a peace deal. President Trump has threatened to impose a blockade on all maritime traffic entering and exiting Iranian ports from today at 10 a.m. Washington time.
• There is a heavy calendar of central bank speakers in the week ahead, including New York Fed Chair Williams and Fed Governors Barr, Bowman, Miran and Waller. In Europe, BoE Governor Bailey and ECB President Lagarde are also scheduled to speak. Market participants will be listening closely for any signals on how major central banks’ views on the impact of the Middle East conflict are evolving. Among the major central banks, the Fed appears most comfortable leaving rates on hold, while the BoE and ECB have signalled they are prepared to raise rates in response to upside inflation risks.
• The key economic data releases in the week ahead include: (i) China’s Q1 GDP report, (ii) the UK monthly GDP report for February, (iii) the US Producer Price Index and import price data for March, and (iv) Australia’s employment report for March. We do not expect these releases to be major market movers. However, China’s Q1 GDP figures will be closely scrutinized to gauge how well the economy is holding up amid the energy price shock, although it remains too early to draw firm conclusions.