USD: Fed risks and Middle East tensions – MUFG

MUFG’s Derek Halpenny notes the US Dollar is broadly steady as resilient US equities and strong earnings temper risk aversion despite escalating Middle East tensions and a prolonged closure of the Strait of Hormuz. He expects Fed Chair Powell to sound somewhat more hawkish, with rising front-end US yields reinforcing improving Dollar demand and building EUR/USD downside and USD/JPY upside risks.

Fed caution as conflict risk builds

"Given the resilience of corporate earnings growth, it is understandable why investors are willing to make optimistic assumptions over how the Middle East conflict will play out over the coming weeks and months. Favourable risks conditions appear to us to be a factor weighing on US dollar performance."

"Crude oil is again trading back above the USD 110pbl level with potential economic consequences over the summer period becoming more severe. Europe and Asia will be more severely hit and if this drags on there will be increased downside pressure on the euro and Asian currencies."

"This is the backdrop for this evening’s FOMC meeting, and we should expect to hear a key message from Fed Chair Powell that the monetary stance is well placed currently given the level of uncertainty. There are unlikely to be any strong message on guidance specifically with Powell likely to emphasise there being available time to assess the risks."

"However, at the margin we would expect Fed Chair Powell to come across more hawkishly than at the last press conference in March. There are signs emerging of inflation risks and with the economy resilient and US equity markets remaining resilient, inflation risks are surely building."

"While we doubt Powell will be aggressively hawkish (given its probably his last press conference) there is a case for emphasising building price stability risks and that will likely see a jump in yields at the front-end of the US curve that should reinforce the emerging signs of improving US dollar demand. EUR/USD downside risks and USD/JPY upside risks are building."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)