Renewed Middle East hopes weigh on the buck

USD

The dollar whipsawed on Thursday in a session that distilled the past month of trading into a single day. May PPI came in hot, with final demand prices up 1.1% MoM against the 0.7% expected, lifting the annual rate to 6.5%, hardening the case for a hike this year and initially extending the greenback's bid, even as jobless claims rose to 229k. Geopolitics then took over. After the most intense US-Iran exchanges since April's ceasefire, including Iranian missile strikes on US bases in Jordan, Kuwait, and Bahrain, President Trump announced he had cancelled Thursday evening's planned strikes and claimed a "great settlement of the war with Iran", with signing expected within days and the Strait of Hormuz to reopen once finalised. Risk roared back, Brent slid below $90, and safe-haven dollar demand faded, pulling the DXY back from the 100 threshold it had been knocking on. With Tehran yet to confirm any deal, headline risk cuts both ways today. June's preliminary University of Michigan survey at 15:00 BST, particularly inflation expectations, is the last notable data point before Wednesday's FOMC — Chair Warsh's first.

EUR

As we anticipated, the ECB's 25bp hike itself proved a non-event, but the messaging mattered. The Governing Council lifted the deposit rate to 2.25%, signalling that the ECB will not simply look through the energy shock. New projections see headline inflation averaging 3.0% this year, growth was cut to just 0.8%, while guidance stayed firmly meeting-by-meeting with no pre-commitment. Sources stories post-meeting offered conflicting views on the prospect of a rate increase in July. With no firm signal on any follow-up moves, EURUSD slipped towards 1.15, before the overnight peace headlines and softer dollar lifted the pair back toward the 1.16 level this morning. Looking ahead, final May CPI readings, due throughout the day, are unlikely to move the needle. Instead, confirmation or rejection of the US-Iran settlement is the key catalyst — a signed deal that reopens Hormuz would ease the bloc's painful terms-of-trade squeeze and should see the euro outperform. Absent that, we expect consolidation in the mid-1.15s into next week's Fed and BoE meetings.

GBP

Sterling spent a third consecutive session as a passenger, with cable initially dragged into the low 1.33s on Thursday before recovering towards 1.34 overnight as Middle East de-escalation hopes sapped haven demand. To us, that is a little surprising: we would have expected greater underperformance, given the resignation of the Defence Secretary in a row over funding – further destabilising the government. Still, the domestic calendar finally offers something this morning, with April GDP numbers published at 07:00 BST. After a strong first quarter, in which output grew 0.6% in the three months to March, the economy slipped back in April, shrinking -0.1% MoM. This feeds directly into Thursday's BoE decision, where markets have pared back hike bets, leaving the MPC looking comparatively dovish against a hiking ECB. Still, we think political developments are the key thing to watch from a sterling perspective headed into the weekend. Confirmation of a US-Iran deal would clearly favour risk-sensitive pound against the greenback, even as domestic events remain an overlooked sterling negative factor.

CAD

Having traded sideways after Wednesday's BoC hold at 2.25%, the loonie endured a rollercoaster Thursday, seeing USDCAD temporarily break above 1.40, before slipping back overnight to trade the high-1.39s this morning. Today's tug-of-war is unusually stark for the loonie: Brent's fall, extending below $90 on peace hopes, erodes Canada's terms of trade, but the accompanying risk rally cuts the other way. With the domestic calendar bare and the next BoC decision not until July 15th, following Macklem's framing of weak growth and rising inflation as a policy dilemma, external forces remain firmly in charge. On balance, we suspect the risk channel dominates near term if a deal is signed, but with markets still pricing a hawkish Fed into Wednesday's FOMC, rallies in the loonie should prove limited, and we would not yet rule out another test of 1.40 should the settlement unravel.

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