Central Banks and Oil Prices: The Impact on Global Currency Trends

Let's get to the big story.

Breakdown.

The Federal Reserve staying on hold as widely expected, but with the Middle East conflict in its third week, surging energy prices are pushing investors towards the US currency.

Now the crisis is also upending global diplomacy, and Trump postponing his upcoming trip to Beijing.

Today.

Trump is set to meet Japanese Prime Minister Sana Takaichi to discuss economic security as well as critical supply chains now.

The big question is whether we will see a repeat of the massive dollar surge from the 20022 or central banks will take a different path this time while joining us from London to weigh in is Francesco Pesole, an FX Strategist at ING.

Good morning.

Good afternoon to you Francesco.

Thank you so much for joining me while central banks and geopolitics are taking center stage this week.

So what do you make of the price action and the reaction we're seeing across the market.

Well, I don't think we've seen a very big reaction so far, which is not surprising.

Well, the dollar was a bit stronger after the Fed.

Markets sensed a bit of a hawkish vibe in Powell's words in the press conference, but aside from that, we got into this very busy week for central bank meetings with uh currencies not really responding much to rate expectations swings.

We had massive reprising of rate expectations, um, especially when it comes to the ECB and.

We should have seen the euro dollar trading much on the strong, much more on the strong side if markets were really paying that much attention to rate differentials, but they simply aren't.

They're looking at oil that remains the number one driver, and I think after what we heard from the Fed yesterday, what we're likely to be hearing from the ECB today, in our view, which is not going to be too much in terms of guidance, we think oil will remain very firmly in the driver's seat.

And speaking of which, the Federal Reserve was quite different from previous press conferences for Jay Powell, but as you mentioned, we're monitoring oil volatility and risk have also been moving all asset classes since the beginning of the Mideast conflict.

So how much higher can the US currency really go from here?

Well, that is obviously a function of how long this conflict will last, a function of how long the oil supply disruptions can can last.

In our view here at ING, we're we're not far from the peak for the dollar.

We we came up with a number of scenarios for the war and and oil prices and in our baseline scenario, we should be close to sort of like the worst in terms of oil prices right now.

Um, and, and according to that, we, we will still be looking at rate cuts by the Fed in the second half of the year that would still keep sort of like the medium term bearishness on the dollar intact, and we would expect the Euro dollar to move back towards $120 towards the end of the year.

Now, obviously the longer the conflict lasts, the longer those oil and gas disruptions last, uh, the more the less likely we will see sort of like a big euro dollar rebound.

Um, in a scenario where we are and we, we get in a longer prolonged conflict and prolonged, um, oil, oil shock, uh, we would be looking at uh a return to 1 uan or below in your dollar.

Yes, and as you mentioned, all of us are keeping an eye on central banks as well as the conflict in the Middle East, and today Japanese Prime Minister Sana Takaichi will be meeting with Trump.

The BOJ kept rates steady as widely expected, but also noted inflation risks are tilted to the upside due to the Iran war, and we know that the BOE as well as the ECBBOJ are all monitoring energy prices here.

So what do you expect to see when it comes to the crosses, especially with the yen?

Yeah, you know, the yen has had its own share of issues before, before the war started.

Obviously, Japan being so exposed to energy prices has just sort of accelerated this dollar yen rally.

We are now close to, you know, 160, which is the level beyond which FX intervention will become very likely.

By Japanese authorities, it's now a matter of whether Japanese authorities feel comfortable stepping into a market that is quite volatile, and that is often a bit of a risky move when it comes to FX intervention.

But for now, dollar yen, like most other dollar crosses, remains very much a function of whatever is happening in the oil market much more than what is happening in central banks.

Francesca, I do want to round out our discussion by looking at commodity currencies.

So countries that export a lot of energy have seen their currencies maintain strength alongside the US currency.

So do you think those gains will last, or are they also at risk if the global equity markets continue to pull back here?

Yes, as you mentioned, you know, those commodity currencies have the positive exposure to energy prices, but then at the same time they tend to have an elevated correlation with equities, so.

I think the Australian dollar was a very good example.

It had an incredible run at the beginning of the war, especially in crosses outside of the US dollar, and then as soon as equity markets started to show more turmoil, it corrected.

I think the currencies that will be able to sort of like retain most gains are those that have a positive domestic.

Story as well, which is why here at ING we keep pointing to the Australian dollar as having more potential to retain those those gains as opposed to the Canadian dollar.

In Canada we will be, we will be hearing more and more about the USMCA renegotiations in coming months.

That is a downside risk for the Canadian economy.

It's a downside risk for the currency.

Australia not only is in a relatively desirable position geographically far away from the.

From the conflict but also has a stronger domestic outlook and above all a central bank that has shown a lot of sort of preparedness for hiking rates and we already saw two hikes and they were the only central bank that actually did hike rates on the back of the Iranian war in G10.

So for the moment we still look at the Australian dollar with more favor than the Canadian dollar.

Francesca, we will have to leave it there for today, but thank you so much for joining us and thank you so much for sharing all of your insights.