USD: Geopolitical risk opens room for brief dollar rebound – ING

Source Fxstreet

The dollar is stronger across the board this morning after Israel attacked Iran's nuclear facilities. The main transmission channel from this specific geopolitical risk and FX is the price of oil, which has rallied around 8% since the Israeli strike. In other conditions, the DXY rally would likely be much larger than the roughly 0.75% rebound from the overnight lows we have seen so far, because the dollar would also benefit from the negative shock in equities and bonds. But USD’s traditional correlations have disappeared of late, and it’s likely that the 1.5% drop in S&P 500 futures is doing more to cap gains, ING's FX analyst Francesco Pesole notes.

USD’s traditional correlations have disappeared

"What matters most for FX at this stage is the depth and length of the Middle East escalation's impact on oil prices. The key difference from previous Israel-Iran standoffs is that nuclear facilities have now been targeted, and while oil production does not seem to be affected just yet, markets have to add in a bigger risk premium given the crucial role of Iran in global oil supply. The next key risk is whether further escalations lead to disruptions in the Strait of Hormuz, which can seriously impact flows from the Persian Gulf, where most of OPEC’s spare capacity incidentally sits."

"While it’s hard to speculate on the situation at the moment, Israel has announced more strikes will follow and Iran's retaliation has already started. The risks now point more definitively towards a prolonged period of tension, in contrast to recent episodes. And we think this could continue to take some pressure off the dollar. While the US may well intervene with oil reserves to curb excessive price spikes, the new risk premium added to crude means inflationary risks are rising at a time when the bulk of the price impact from tariffs in the US is set to materialise."

"We had felt the USD negative reaction to the soft CPI print was exaggerated, and new geopolitical tensions give the Fed another argument to stay cautious, arguing for that CPI move to be scaled back. Today, the US calendar includes the University of Michigan surveys, which have generally painted a grimmer picture of inflation and sentiment than other indicators."

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