Forex Today: Mood sours as Mideast conflict widens, focus shifts to Fed
Here is what you need to know on Wednesday, July 29:
Markets turn risk-averse midweek as the crisis in the Middle East widens. Later in the American session, the Federal Reserve (Fed) will announce its interest rate decision and publish the policy statement following the two-day meeting.
Saudi forces have joined the conflict by launching attacks on Iran-aligned groups in Iraq alongside the United States (US), as retaliation to the Islamic Revolutionary Guard Corps' (IRGC) drone attacks on Saudi oil facilities. Meanwhile, Iran claimed an attack on a US military base located in Jordan. Following a two-day decline, crude Oil prices push higher on Wednesday, with the barrel of West Texas Intermediate (WTI) trading above $81, rising nearly 4% on the day.
Oil rebounds as Middle East attacks end recent truce-driven sell-off
According to Deutsche Bank, the recent calm in oil markets has been abruptly interrupted, with sentiment having "soured overnight as the US said that it intercepted an Iranian attack against its bases in the Middle East," effectively ending the brief pause in hostilities. The bank notes that this lull had seen Brent crude "decline from above $100/bbl last Thursday to only $84.09/bbl at yesterday’s close," a move they describe as its "sharpest three-day decline (-16.5%) since April 2020."
ING analysts add that "after a heavy sell-off in the oil market over the last three days, prices popped higher in early morning trading, with Brent up more than 4% at the time of writing." They attribute this "renewed strength" to the latest escalation, highlighting that it "comes after the US said it intercepted a surprise attack on US troops." ING further points out that "Saudi Arabia intercepted drones from Iranian-backed groups in Iraq, which were targeting Saudi energy infrastructure," underscoring how the emerging security risks are feeding directly back into crude prices.
The US Dollar (USD) Index struggles to benefit from risk-aversion and holds steady at around 101.30 in the European session, as investors refrain from taking large positions ahead of the Fed policy announcements. While the Fed is anticipated to keep the interest rate unchanged, the CME FedWatch Tool shows that there is about a 30% chance of a 25 basis points (bps) hike.
After posting small gains on Tuesday, EUR/USD trades in a narrow channel at around 1.1400 early Wednesday.
GBP/USD corrects higher and trades a few pips above 1.3300 in the early European session.
Fed risk keeps front-end Euro and Pound markets on edge
Analysts at ING argue that the FOMC is likely to stay on hold, stating, “We don't think the FOMC will hike rates, but markets see a 30% probability that it does.” They note that a more hawkish tone alone could see “the front end of the EUR and GBP markets… move even higher on a hawkish tilt,” while “longer-dated global rates, however, could find resistance to follow through, especially if the positive market sentiment gets challenged by a tightening of financial conditions.”
ING also flags the risk of a more adverse outcome if the Fed does deliver a surprise hike, warning that “market sentiment takes a hit if the Fed hikes as risk assets suffer from tighter financial conditions,” with “increasing jitters in equities on the back of AI uncertainties” already evident. In such a scenario, they suggest “the curve reaction should be of interest,” as investors reassess the balance between front-end repricing and the ability of long-end yields to keep pace.
The data from Australia showed earlier in the day that annual inflation, as measured by the change in the Consumer Price Index (CPI), declined to 3.8% in June from 4% in July. This print came in below the market expectation of 4%. AUD/USD remains under bearish pressure on Wednesday and trades at a fresh two-week low near 0.6950.
Gold holds steady above $4,000 after posting losses for two consecutive days.
USD/JPY edges lower and trades at around 163.50 in the European morning on Wednesday.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two mandates: to achieve price stability and foster full employment. Its primary tool to achieve these goals is by adjusting interest rates. When prices are rising too quickly and inflation is above the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US Dollar (USD) as it makes the US a more attractive place for international investors to park their money. When inflation falls below 2% or the Unemployment Rate is too high, the Fed may lower interest rates to encourage borrowing, which weighs on the Greenback.
The Federal Reserve (Fed) holds eight policy meetings a year, where the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. The FOMC is attended by twelve Fed officials – the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional Reserve Bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may resort to a policy named Quantitative Easing (QE). QE is the process by which the Fed substantially increases the flow of credit in a stuck financial system. It is a non-standard policy measure used during crises or when inflation is extremely low. It was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more Dollars and using them to buy high grade bonds from financial institutions. QE usually weakens the US Dollar.
Quantitative tightening (QT) is the reverse process of QE, whereby the Federal Reserve stops buying bonds from financial institutions and does not reinvest the principal from the bonds it holds maturing, to purchase new bonds. It is usually positive for the value of the US Dollar.
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