A round trip for the dollar on US-Iran deal prospects
US dollar volatility rises as fragile US–Iran deal optimism fades. Markets reassess risk, with focus shifting to central banks and the upcoming FOMC meeting driving FX direction.
USD
The dollar initially drifted lower on Monday after Washington and Tehran confirmed a framework deal to extend their ceasefire by 60 days and reopen the Strait of Hormuz, with signing pencilled in for Friday. As we cautioned yesterday, however, this optimism is brittle. The text is unpublished, the Strait remains shut, and hostilities grind on – a mix that is now seeing the dollar retrace as doubts begin to emerge. Middle East developments aside, two central banks moved overnight. The BoJ raised rates 25bp to 1%, a 31-year high, with Deputy Governor Uchida fronting the press conference in the hospitalised Ueda's absence, leaving USDJPY either side of 160 and intervention risk alive. Meanwhile, the RBA held at 4.35%, its first pause after three hikes, but kept a hawkish tilt. Attention now swings to tomorrow's FOMC, Chair Warsh's first, where a hold at 3.50–3.75% is near-certain, and the dot plot and guidance are the real story.
EUR
EURUSD extended its recovery on Monday, edging back to around 1.16 as the softer dollar and brighter risk tone did the heavy lifting, before dipping back late in the session, prompted by a dollar reversal. The domestic calendar is bare today, with only ZEW survey numbers due, so the single currency stays a function of the dollar leg and the Middle East narrative into tomorrow's Fed. The medium-term case is constructive: a signed deal that reopens Hormuz would ease the bloc's punishing terms-of-trade squeeze and argue for euro outperformance in time. For now, though, with the fighting still live and the agreement unsigned, we expect EURUSD to consolidate within a 1.15–1.16 range, with direction handed to Chair Warsh on Wednesday.
GBP
Sterling tracked the global risk rally early on Monday, with cable firming back toward the mid-1.34s as the dollar softened, before retracing overnight. As we have argued previously, however, the pound is not pricing the political risk we see building, leaving sterling scanning as overvalued at present. The government remains in disarray after last week's resignations of Defence Secretary John Healey, and focus now shifts to Thursday's Makerfield by-election, where Greater Manchester mayor Andy Burnham is strongly favoured to win. This, we think, helps explain the pound’s underperformance on crosses yesterday, with GBPEUR slipping several tenths despite the lack of an obvious catalyst. And that is all before considering a Bank Rate decision later this week, too. With the BoE and the by-election landing the same day, and May CPI in between, we continue to think the risks to sterling are skewed to the downside.
CAD
The loonie's tug-of-war continued on Monday, ultimately ending in a stalemate, with neither risk conditions nor oil prices able to durably dictate direction. With the domestic calendar empty and the next BoC meeting not until 15 July, external forces remain firmly in charge. The near-term path hinges on the US-Iran deal: a credible reopening would likely take USDCAD lower, albeit with loonie upside limited by lower oil, whereas any unravelling would revive the safe-haven dollar and put a sustained move above 1.40 back in view. With markets also braced for a hawkish hold from the Fed tomorrow, we doubt the loonie can extend yesterday's gains - we look for USDCAD to continue flirting with 1.40 until a credible peace deal is agreed.