Dollar Holds Firm Amid Geopolitical Risks
The dollar remains close to seven-week highs as hawkish Federal Reserve expectations and renewed Middle East tensions support safe-haven demand, while EUR, GBP and CAD face pressure from energy market uncertainty.
USD
The dollar begins the week close to seven-week highs following a period dominated by central bank decisions and escalating geopolitical tensions. The Federal Reserve raised rates by 25bp on 16 September, taking the Fed funds target range to 3.75%-4.00%, while updated projections pointed towards a meaningful possibility of another move before year-end. We highlighted last week that the combination of persistent inflation concerns, elevated energy prices and geopolitical uncertainty lowered the bar for further tightening. The immediate post-FOMC rally in the dollar moderated towards the end of last week as Treasury yields eased from their highs, but renewed tensions in the Middle East, including reports of attacks on shipping near the Strait of Hormuz, helped maintain underlying support for the greenback. Looking ahead, our Week Ahead outlook continues to favour the dollar as quarter-end approaches. The US calendar is relatively light today, meaning market focus is likely to remain on Fed expectations, energy markets and broader risk sentiment. With investors continuing to assess whether October could deliver another rate increase, the dollar is likely to remain well supported, particularly while geopolitical tensions continue to generate demand for safe-haven assets. Flash PMI surveys later this week will provide a key indication of whether resilient US economic momentum remains intact.
EUR
The euro recovered modestly towards the end of last week, gaining ground against the dollar as oil prices eased following indications that part of Saudi Arabia's damaged East-West pipeline capacity could be restored within days. EUR/USD finished Thursday just shy of 1.15 after crude prices fell and some of the immediate inflation fears linked to energy supply disruptions eased. Nevertheless, the single currency remains highly sensitive to developments in energy markets. Despite the ECB's 25bp rate increase earlier this month, higher European interest rates have provided only limited support as investors continue to focus on the economic consequences of elevated energy costs and ongoing disruption to key shipping routes. For the week ahead, September flash PMI surveys will be particularly important in assessing the resilience of Eurozone growth. We continue to expect energy markets and developments in the Middle East to remain a key driver of EUR performance. Any renewed escalation that pushes oil prices higher is likely to prove a headwind for the Eurozone economy given the region's energy dependence. Attention will also turn to Thursday's policy decisions from the SNB, Norges Bank and Riksbank, which could shape broader European rate expectations. While the euro has stabilised in recent sessions, risks remain tilted towards a firmer dollar backdrop in the near term.
GBP
Sterling underperformed its major peers following last Thursday's Bank of England meeting. The MPC left Bank Rate unchanged at 3.75% in a 6-3 vote, with Greene, Mann and Pill continuing to support an immediate increase. While the headline outcome matched expectations, the accompanying communication carried a distinctly hawkish tone. Bank staff revised inflation projections higher, while Governor Bailey and several MPC members indicated that prolonged conflict in the Middle East, if accompanied by further energy price pressures, could ultimately require tighter policy. Despite that shift, sterling weakened against the dollar and traded in the mid-1.33s at the end of last week as markets focused on the relative hawkishness of the Federal Reserve. Looking ahead, the pound faces competing influences. On the one hand, rising energy costs and inflation risks support the case for tighter policy. On the other, elevated gilt yields and a softer domestic growth backdrop argue for caution. We continue to monitor whether recent comments from MPC members translate into stronger market expectations for a year-end hike. Near term, sterling direction is likely to remain driven by broad dollar performance and developments in energy markets. Any escalation in Middle East hostilities that pushes oil prices higher could further complicate the Bank of England's policy outlook and increase volatility in GBP crosses.
CAD
The Canadian dollar enters the week caught between two important forces: changing oil-price dynamics and the increasingly hawkish Federal Reserve outlook. Towards the end of last week, oil prices softened as markets responded positively to reports that Saudi Arabia could restore part of its disrupted pipeline network. That development reduced some of the immediate support normally provided to commodity-linked currencies and helped keep USD/CAD close to the 1.40 area. At the same time, stronger Canadian producer price data reinforced the view that higher energy costs are feeding through the domestic economy, although the Bank of Canada remains expected to leave policy unchanged in the months ahead. The outlook for CAD remains heavily tied to developments in the Middle East. While signs of improving oil infrastructure capacity briefly reduced market concerns, reports of attacks on shipping have demonstrated how quickly the geopolitical risk premium can return. As a result, oil markets are likely to remain highly volatile throughout the week. We expect USD/CAD to continue balancing support from elevated energy prices against the broader strength of the US dollar. With the domestic Canadian calendar relatively quiet, geopolitics, crude oil and US rate expectations are likely to remain the dominant drivers of CAD price action.