FX markets look past geopolitics
Market overview
Weekend talks between the US and Iran in Switzerland gave markets another reason to look past the worst-case scenario, with both sides describing the opening round as constructive and signalling a willingness to continue negotiations this week. The Strait of Hormuz remains central to the story, while the Israel-Lebanon conflict still threatens progress towards de-escalation.
For FX, however, the geopolitical impulse is fading. After weeks of softer rhetoric, much of the good news looks priced in. Investors are shifting back to inflation, oil and policy rates, with hawkish central banks and rate differentials once again setting the tone.
USD: Fed credibility gives the dollar a cleaner runway
The dollar was the clearest beneficiary of last week’s policy repricing. The latest Federal Reserve meeting delivered a hawkish dot plot, while Chair Warsh’s focus on price stability helped reinforce the message that the Fed remains alert to inflation risks. The DXY gained around 1% over the week as markets rebuilt confidence in the policy path.
The reaction to Warsh’s press conference was also broadly positive. Concerns around Fed credibility eased, and investors appeared more comfortable with a framework that places less emphasis on forward guidance and more weight on incoming data.
That leaves this week’s PCE release as the key near-term test. Inflation is expected to edge higher, which should support the current dollar narrative. However, after last week’s move, an in-line print may be more consolidative than explosive.
Technically, 101 is the next upside marker for DXY. Support sits at 100.50 and 100. The latter had capped rallies for several months and now looks more likely to hold on pullbacks following the Fed-led breakout.
GBP: Sterling steadies, but politics adds a layer of risk
Sterling remains under pressure after the Bank of England sounded less hawkish than markets had expected. The move was most visible in GBP/USD, where the combination of a softer BoE tone and a hawkish Fed pushed the pair towards late-March lows near 1.32. Support has held just above that area for now.
GBP/EUR also softened, briefly testing 1.1507 on Monday before recovering towards 1.1535. Markets have moved closer to pricing a BoE that could remain on hold for the rest of the year, while a sizeable part of the FOMC still leans towards at least one further hike. That policy gap could widen if oil prices keep easing as tensions around Hormuz cool.
Domestic politics adds another source of uncertainty, although the bar for a deeper sterling sell-off still looks relatively high. Andy Burnham’s expected rise has been widely flagged and appears largely priced. His emphasis on fiscal discipline has helped reassure gilt investors, while markets are already familiar with his political profile.
The key issue is process. If Keir Starmer sets out a clear timetable for leaving Downing Street, investors are likely to view the transition as orderly. If no timetable emerges and the focus shifts towards a leadership challenge, sterling could face renewed pressure.
EUR: Fed strength keeps EUR/USD capped
EUR/USD is consolidating near 1.1450 after last week’s sharp decline, which was driven by the Fed’s hawkish shift. The pair is back near levels last seen in mid-March, when US-Iran tensions were at their most intense.
Rate differentials are becoming a stronger driver of price action. The dollar looks better placed to absorb a hawkish policy shift, supported by resilient US data and firmer confidence in the Fed’s reaction function. By contrast, the eurozone growth backdrop remains subdued, leaving the ECB more exposed to the disinflationary impact of lower oil prices.
That matters because oil is now feeding into the euro more through rate expectations than through risk sentiment. With markets largely pricing out a renewed escalation, weaker oil prices may limit how far ECB hawkish bets can build relative to the Fed. That, in turn, caps euro upside.
A return to 1.16 looks unlikely in the near term. EUR/USD is likely to remain close to 1.15, with risks modestly tilted lower this week as the Fed narrative continues to dominate.
Looking ahead
US PCE is the main macro event and should set the tone for the dollar.
An in-line inflation print may support the Fed narrative without forcing a fresh breakout.
DXY support sits at 100.50 and 100, with 101 the next upside level to watch.
GBP remains sensitive to both BoE repricing and the shape of any UK political transition.
EUR/USD upside looks capped while rate differentials continue to favour the dollar.
Oil remains important, but increasingly through inflation and policy expectations rather than risk sentiment.