FX Weekly

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USD upside risks

FX View:

The US dollar advanced 1.3% last week as crude oil prices advanced with Brent up over 11% last week – that gain has extended further at the start of this week. There is as of now no clear, obvious path to de-escalation and hence we see scope for the US dollar to advance further. Based on our regression analysis based on how the dollar responds to a 10% jump in crude oil prices, the EUR/USD drop of 3.0%-3.5% since the crisis began in consistent with the 50% advance from crude oil prices (our analysis shows for every 10% gain, EUR/USD drops 0.7%). This week we outline three scenarios we see as plausible at this stage and what those scenarios means for crude oil prices and the US dollar. We also take assess the FX impact from the large number of G10 central bank meetings this week – with eight of the G10 central banks meeting. Given the still relatively recent start to this crisis, central banks are unlikely to send any strong messages although less tolerance to “looking through” an energy price shock is likely one take-away.

BROAD-BASED USD GAINS VS G10 AS CRUDE OIL PRICE JUMPS FURTHER

Source: Bloomberg, close on 13th March 2026 (Weekly % Change vs. USD)

Trade Ideas:

We are maintain a short EUR/USD trade to reflect the scope for further EUR/USD declines based on energy price rises to-date.

JPY Flows: 

The February portfolio flow data revealed further buying of Japanese equities and bonds. Since PM Takaichi’s LDP leadership election victory last October, foreign investors have bought a record JPY 13trn worth of equities.

IMM Positioning:

The latest IMM weekly positioning data for the week ending 10th March shows that Leveraged Funds have continued to cut back short USD positions since Operation Epic Fury started on 28th February. Long EUR positions have fallen back to their lowest levels since early in November.

FX Views

USD: Scenario analysis points to USD upside risks

We have passed the two-week mark since the start of the conflict in the Middle East and there is no obvious reason for optimism at this stage. The US and Israel have maintained a high level of intensity in attacks on Iran but at the same time Iran has been in a position to maintain a steady rate of retaliation and more significantly has been able to ensure the continued closure of the Strait of Hormuz. DXY has broken through the key 100-level with crude oil prices elevated at around USD 105 p/bl. DXY has traded largely in a 96.000-100.00 range since June last year so this break higher could prove significant and reinforce positive momentum this week. The conflict is of course difficult to predict and hence in these circumstances laying out plausible scenarios and what these scenarios would mean for crude oil prices and the US dollar is a sensible approach. We lay our three plausible scenarios below and what is clear from these is that the risks are clearly skewed to further US dollar strength from here. How equity markets perform will also be important in determining the reaction function of central banks to the clear upside inflation risks that lie ahead. We continue to run a short EUR/USD trade view based on the risk skew of further US dollar gains over the coming weeks.

The length the conflict will be closely tied to the potential severity and hence timelines are important in laying out these scenarios. Scenario 1 is the best case scenario that perhaps investors continue to hold out hope for. This would essentially see de-escalation materialise relatively quickly certainly now with the conflict over two weeks old, de-escalation is over the next week, to ten days, to two weeks max. There is a compelling logic to this still potentially happening with President Trump likely to face increasing pressure domestically if energy prices continue to rise and if the US suffers further loss of lives. With the mid-term elections in November, a renewed rise in gasoline prices and grocery prices that stick for longer would be hugely damaging to the prospects for the Republicans in November. According to the US Central Command (CENTCOM) the US has struck 6,000 Iranian targets since the war began. With the supreme leader and many family members killed and the new supreme leader reportedly badly injured, President Trump could at some stage soon claim victory and move to de-escalate. In Scenario 1 we would see Brent crude oil in a range of USD 75-85 p/bl, which assume a risk premium of USD 10 p/bl is in the price for some time. The US dollar could weaken back modestly with EUR/USD in a 1.16-1.18 range.

But time for Scenario 1 is running out. Optimism over a short conflict has receded and we now may well be in the process of moving from Scenario 1 to Scenario 2. Iran is certainly not letting up and this could mean that politically attempting to de-escalate could be viewed as a sign of weakness that leaves Trump reluctant to de-escalate. If Iran continues its attacks with drones and missiles and attacks more ships in the Strait of Hormuz there is an increasing risk that the expected time of de-escalation gets pushed back by investors and this then results in a reassessment of the extent of the expected supply disruption. This reassessment would see a higher range for crude oil in Scenario 2 – we assume a range of USD 85-120 p/bl. For Europe, this would mean higher natural gas prices as well. Given where the price of crude oil is today, it is certainly reasonable to conclude we are moving from Scenario 1 to 2 already. A crude oil price of USD 110 p/bl would be a near 60% increase from the pre-conflict level which based on our regression analysis would imply EUR/USD falling to 1.1300 – so we assume a Scenario 2 range of 1.1200-1.1600. De-escalation ultimately takes place it just takes longer to achieve than in Scenario 1.

BIGGER CRUDE OIL PRICE SHOCK NOW VS RUSSIA IN ‘22

Source: Bloomberg, Macrobond & MUFG GMR

NAT GAS PRICE SURGE IN EUROPE BUT NOT IN US

Source: Bloomberg, Macrobond & MUFG GMR

As the conflict drags on and concerns over there being no de-escalation rise further, Iran then turns more aggressive and having only previously intermittently hit production facilities, Iran attacks production facilities more aggressively. Like in Scenario 2 but from a higher price level, investors reassess energy supply expectations and with greater production facility damage, energy prices take another leg higher and there remains no obvious sign of an off-ramp toward de-escalation. A 100% increase in crude oil prices and more in natural gas prices in Europe, the dollar gains further with scope for EUR/USD to drop as low as 1.0700. The EUR/USD range is 1.0700-1.1300. In this scenario risks of global recession are much higher and global equities are hit with 15%-20% declines. The G10 FX performance is therefore more mixed with the dollar performing better versus high-beta G10 but CHF and potentially JPY performing better as front-end yields in the US come down.

The crude oil moves in the scenarios above do result in considerable moves higher in headline YoY CPI that could compel central banks to hike rates, certainly here in Europe given the natural gas price surge. The peak for inflation in the UK and the euro-zone in Scenario 2 is between 3%-4%. Scenario 3 would see inflation in the UK and the euro-zone hit between 6%-7% by year-end into Q1 2027. Whether central banks raise rates or to what extent will be determined by broader risk conditions. If equity markets fell notably, the need for rate hikes would diminish somewhat but we should certainly expect less tolerance from central banks on ‘looking through’ the energy price shock and we should not expect to hear the word “transitory” mentioned too much!

The scenarios above point to one clear takeaway – the longer the conflict lasts, the greater the upside risks for the dollar become. Given the scale of moves when compared to the Russia-Ukraine energy shock, a 7%-8% USD gain is plausible.

EZ ENERGY PRICE SHOCK UNDER OUR 3 SCENARIOS

Source: Bloomberg, Macrobond & MUFG GMR

DXY 3MTHS AFTER RUSSIA/UKRAINE VS ME CONFLICT

Source: Bloomberg, CFTC, Macrobond & MUFG GMR

G10 FX: How will central banks react to energy price shock?     

The recent surge in energy prices has triggered an abrupt and broad‑based hawkish repricing of market expectations for central bank policy, reflecting heightened concerns about near‑term upside risks to inflation. IMF Managing Director Kristalina Georgieva warned last week that a 10% increase in energy prices sustained for one year could raise global inflation by 40 basis points and slow economic growth, with the IMF set to provide more detailed analysis in its World Economic Outlook report due next month.

This week’s heavy calendar of G10 central bank meetings will provide further clarity on how policymakers intend to respond to the inflationary shock stemming from the ongoing conflict in the Middle East. Two‑year government bond yields, often used as a gauge of central bank expectations, show a striking divergence in market repricing across countries. The sharpest hawkish adjustment has occurred in the UK, where yields have risen by roughly 57 basis points. At the opposite end of the spectrum, Japan has seen the smallest adjustment, with yields increasing by only around 6 basis points indicating that market participants expect the BoJ to remain cautious over delivering further rate hikes while Japan’s economy will be hit harder by the negative energy price shock.  

The RBA is expected to be the first G10 central bank to respond to the energy price shock by raising interest rates in the week ahead. Market expectations for a second consecutive rate hike have increased following hawkish comments from Deputy Governor Andrew Hauser, who warned that “further increases of prices from Iran, if that is what we end up seeing is not a helpful development from the perspective of our policy discussion.” He also noted that inflation is tracking “higher than the projection we published in February… so it’s important actually that we do take the steps needed to bring inflation back to target.”

Currently, markets are pricing in around 17 basis points of tightening for this week and nearly three rate hikes in total by year end. For the RBA to reinforce this hawkish repricing, it would likely need to both raise rates and deliver a strong signal that further hikes are on the way. The AUD has benefited from rising domestic yields and higher commodity prices so far this year, making it one of the best‑performing G10 currencies alongside the NOK. The main risk to the AUD’s bullish trend would be a further intensification of the oil price shock, which could trigger a sharper slowdown in global growth and a deeper sell‑off in risk assets.

HAWKISH REPRICING OF CENTRAL BANK OUTLOOK

Source: Bloomberg, Macrobond & MUFG GMR

YIELD DIFFERENTIALS LESS IMPORTANT FX DRIVER

Source: Bloomberg, Macrobond & MUFG GMR

In contrast, the other major central banks of the Fed (Wed), BoJ (Thu), BoE (Thu), and ECB (Thu) are all expected to leave rates on hold this week, giving themselves more time to assess the appropriate policy outlook in light of the energy‑driven inflation shock. The Fed had already signalled at the start of this year that it was in no rush to resume rate cuts, a view likely reinforced by the latest jump in energy prices. Nonetheless, we do not expect the Fed to abandon plans for further cuts later this year. The updated DOT plot will be scrutinized closely to determine whether opposition to additional rate cuts is rising. In the December projections, 12 of the 19 FOMC participants supported lower rates this year, highlighting a committee that was leaning toward easing before the recent shock.

Higher energy prices, combined with still‑soft labour‑market conditions, create a more challenging backdrop for the Fed as it seeks to balance its dual mandate of maximum employment and price stability. With policy rates judged to be mildly restrictive, the Fed is not under the same pressure to raise rates as it was in 2022. Following the start of the Ukraine conflict in February 2022, the Fed began tightening in March and ultimately lifted rates by a total of 4.25 percentage points by year end. It was one of the key reasons the USD strengthened sharply by roughly 20% over that period alongside the bigger hit to economies outside of the US from energy price shock.     

Rate cut expectations have been scaled back even more sharply for the BoE. The UK rates market has performed an abrupt U‑turn, shifting to price the next policy move as a hike, with around 13bps of tightening priced in by year end, compared with two full rate cuts priced before the Middle East conflict. The BoE had been moving closer to resuming rate cuts prior to the energy price shock, when it narrowly voted to leave rates on hold in February (5–4 split).  The Bank is expected to signal renewed concern this week about the risk of persistent inflation pressures stemming from the energy shock. In the near term, the elevated uncertainty surrounding the inflation outlook is likely to encourage a stronger majority to vote to keep rates on hold until greater clarity emerges. The updated communication may open the door to tighter policy if required to contain upside inflation risks, while emphasising that the policy outlook remains conditional on the duration of the energy price shock. Like the Fed, the BoE’s policy rate is judged to be mildly restrictive, which helps ease immediate pressure to respond by raising rates.

In the FX market, the sharper hawkish repricing of UK rates has supported GBP strength against other European currencies in recent weeks. EUR/GBP has fallen back toward the lows seen since the middle of last year, around 0.8600. The GBP also strengthened initially against the EUR at the start of the previous energy price shock in early 2022, although those gains proved short‑lived. 2022 was a particularly difficult year for the GBP, as it was first hit by the global energy price shock and then by former Prime Minister Liz Truss’s “Mini‑Budget” in the autumn, which severely undermined market confidence. 

USD DIVERGES FROM YIELD DIFFERENTIALS

Source: Bloomberg, Macrobond & MUFG GMR

G10 FX PERFORMANCE VS. TERMS OF TRADE SHOCK

Source: Bloomberg, Macrobond & MUFG GMR

The BoJ and ECB are now expected to be the most active major central banks in tightening policy. While expectations for BoJ rate hikes have not changed significantly in response to the energy price shock, the euro‑zone rates market has shifted sharply, with around 42bps of ECB hikes now priced in by year end, compared with expectations of a possible additional cut before the shock. This repricing has been supported by a series of hawkish comments from ECB officials. Executive Board member Isabel Schnabel has urged policymakers to remain “vigilant” and closely monitor the persistence of the energy‑price shock. Bundesbank President Joachim Nagel stated that “if it becomes apparent that the current energy‑price increases will translate into broad consumer‑price inflation in the medium term, the Governing Council of the ECB will act decisively in a timely manner,” although he continues to back a “wait‑and‑see approach” for now. Governing Council member Peter Kazimir went even further, warning that “a reaction by the ECB is potentially closer than many people think. I don’t want to speculate about April or June. But we will be ready to act if needed.”

Unlike the BoE and the Fed, the ECB’s policy rate has already returned to its estimated neutral range of 1.75% to 2.25%. As a result, the ECB may feel more immediate pressure to lift the policy rate back into restrictive territory if upside inflation risks continue to build. This could contribute to a relatively more hawkish tone at this week’s policy meeting. President Lagarde will likely need to acknowledge that the ECB’s earlier assessment that policy is currently in a “good place” is now being challenged by the latest energy‑price shock. Isabel Schnabel has already suggested that the updated inflation projections will partially reflect these recent developments, reducing some of the buffer the ECB previously believed it had. Before the shock, ECB staff had forecast a modest inflation undershoot for this year and next, offering some leeway to absorb the inflation lift from higher energy prices. However, the increasingly hawkish repricing of ECB policy expectations is unlikely to prevent further EUR weakness, given the bigger negative terms of trade shock facing European economies from more expensive energy imports. EUR/USD has now broken below support at 1.1500, reinforcing our short EUR/USD trade idea (click here).

Rate hike expectations have risen the least in Japan in response to the energy price shock. The Japanese rates market was already pricing in another BOJ hike as soon as April, followed by a second increase later in the year, and these expectations have not changed significantly in recent weeks. The combination of higher energy prices and a weaker JPY has supported expectations for additional BOJ tightening. The JPY has weakened to reflect expectations that Japan’s economy is likely to be hit harder by the energy price shock given it is heavily reliant on imported energy.

We will be watching closely to see whether the shock pushes the BOJ to signal that it is moving closer to another hike, or whether it instead encourages the Bank to adopt a more cautious stance that delays further tightening. Japanese media have also reported that Prime Minister Takaichi recently “voiced displeasure” over plans for early rate hikes, adding another layer of uncertainty to the near‑term policy path.  With the following BOJ meeting not scheduled until 28^th  April, when policymakers will have much greater clarity on the scale and persistence of the energy‑price shock, the BOJ may refrain this week from strongly committing to an April hike. In the absence of a firm signal pointing to a near‑term hike, it would encourage further JPY selling, lifting USD/JPY back above 160.00. By allowing USD/JPY to rise above 160.00, it would also indicate that Japan’s near-term tolerance for a weaker JPY has also increased in response to the energy price shock.

Weekly Calendar

Source: Bloomberg & MUFG GMR

Key Events:

• The main focus in the week ahead will remain on geopolitical developments in the Middle East, which are likely to continue driving foreign exchange market performance. A quicker end to the conflict would help ease concerns about supply disruptions, while further retaliatory strikes by Iran on energy infrastructure would significantly heighten those risks.
• Greater clarity on how G10 central banks intend to respond to the latest energy‑driven inflation shock should emerge in the coming week, with major policy meetings scheduled for the RBA (Tue), BoC (Wed), Fed (Wed), BoJ (Thu), SNB (Thu), Riksbank (Thu), BoE (Thu) and ECB (Thu). The RBA is expected to become the first G10 central bank to raise rates in response to rising inflation risks — marking a second consecutive hike at the start of the year. If the RBA does deliver a hike, markets will be watching closely to see whether policymakers signal openness to additional tightening this year.
• In contrast, the other G10 central banks are generally expected to emphasize that they are waiting to assess how the energy shock evolves before determining the appropriate policy path. The Fed, in particular, will need to weigh upside inflation risks from higher energy prices against further evidence of weak labour market conditions. We expect the Fed to reiterate that it is in no hurry to resume rate cuts this year.
• In Europe, both the BoE and the ECB are likely to express increased concern about upside inflation risks stemming from higher energy prices. Heightened uncertainty is likely to encourage a more unified BoE vote to keep rates on hold this week. The ECB may sound relatively more hawkish than both the Fed and the BoE. We expect the ECB to acknowledge that the conflict is challenging its assessment that policy is currently in a “good place” and may open the door to rate hikes if necessary to return policy to a more restrictive stance—potentially back above the 1.75–2.25% range.
• The BoJ is expected to leave rates unchanged this week. Markets will closely scrutinize updated policy guidance to gauge whether the BoJ is comfortable with current expectations for a rate hike as early as next month.