Middle East tensions underpin oil and the dollar

USD

The dollar firmed for a second day on Tuesday, the DXY consolidating around 101 as 10-year Treasury yields rose to 4.63% and markets pared Fed easing bets. Notably, the greenback gained despite a risk-on session that saw the S&P 500 climb 1.0% on a chip-led rebound, underscoring the stagflationary impulse stemming from the Middle East. A mediator proposal for a 10-day truce briefly knocked crude in early trade, but a fresh tanker attack in the Strait of Hormuz and continued strikes saw WTI settle 2.5% higher near $84. Hostilities have since entered an eleventh day, with President Trump overnight playing down near-term talks, threatening to widen strikes to Iranian nuclear sites, and warning the Houthis over Red Sea shipping, lifting Brent towards $92 this morning. With the Fed in blackout before the July 29th decision and only oil inventories due, attention falls on Tesla and Alphabet earnings after the close. We still see the near coin-flip September odds as vulnerable to a cooling US economy, though the energy premium caps dollar downside for now.

EUR

The euro slipped towards the bottom of the 1.14s on Tuesday, unable to capitalise on a stellar ZEW report that saw the German expectations index jump to 26.3, smashing the circa-15 consensus in the first confidence reading since the latest Hormuz flare-up. That domestic resilience was overshadowed by broad dollar strength and a deteriorating terms-of-trade backdrop, with Brent extending a fourth straight daily advance overnight as US-Iran hostilities intensified — an unhelpful mix given half-full gas storage ahead of the heating season. With the Governing Council in its quiet period and little of note domestically today, the single currency should trade off energy and risk conditions ahead of tomorrow's rate decision. We continue to think this meeting comes too early for another move after June's hike took the deposit rate to 2.25%, leaving the focus squarely on whether President Lagarde keeps a September hike alive. A sustained closure of the Strait of Hormuz argues that she should, but until that rate leg firms, we see near-term euro risks as tilted modestly lower.

GBP

Sterling stayed on the back foot on Tuesday, cable sliding back below 1.34 as broad dollar strength compounded lingering unease over the new government's fiscal intentions. As we anticipated, yesterday’s labour market report did little to move the needle. Both the unemployment rate and pay growth landed unchanged at 4.9% and 3.4% respectively. This morning's June CPI has vindicated our call for a softer-than-expected headline print, seeing inflation slow to 2.6%, below the 2.7% consensus and a fifteen-month low, led by falling fuel, food, and clothing prices. That said, the pound has slipped only marginally in response, with core price growth surprising 0.1pp to the upside. As with yesterday’s data, this mix does little to shift the picture for the MPC, with Bank Rate set to remain on hold later this month. As such, politics should remain in focus for GBP traders. Having cut VAT on electricity bills yesterday, Chancellor Healey announced a £2 bus fare cap this morning, underlining the Burnham government's cost-of-living focus, even as questions over fiscal rule "flexibility" linger. We retain a modest downside bias pending Budget detail.

CAD

The loonie began Tuesday again under pressure after the Trump administration announced 50% tariffs on roughly $20bn of Canadian goods. Some of that damage faded through the session, however, as Prime Minister Carney and President Trump agreed to intensify negotiations, and as war-driven supply fears lifted WTI. That resilience is also notable given Monday's soft CPI report, which saw core inflation fall to five-year lows and, as we argued, should kill off BoC hiking bets entirely. Still, USDCAD trades around 1.41 this morning, reflecting the deterioration in macro support, even if damage could have been more pronounced. With the domestic calendar bare today, the loonie remains hostage to trade headlines, oil prices, and risk appetite, with talk of dollar-for-dollar retaliation from provincial leaders sitting uneasily alongside Ottawa's diplomacy. We expect USDCAD to hold around current levels near term, though with both the Fed and BoC on hold, closing rate differentials should favour a grind lower over the medium run.

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