Market overview

Risk appetite has regained some momentum, and FX markets are beginning to reflect it. Lower volatility has encouraged investors to move beyond pure safety trades and revisit yield opportunities, helping emerging market currencies recover part of their recent setback.

This is not a wholesale return to risk. Investors are being more discerning, favouring currencies where yield is supported by stronger fundamentals and less direct exposure to energy shocks.

The Strait of Hormuz remains central to that assessment. Markets are not treating the situation as a binary risk, but are instead asking whether disruption becomes large and persistent enough to create a lasting inflation shock. If shipping risk can be absorbed as a risk premium, rather than seen as a systemic rupture, the strain on risk assets should remain in check.

USD: Safe-haven premium fades, but support is close by

The Dollar’s recent strength has been closely tied to fears of disorderly geopolitical outcomes. As those risks look more contained, its safety premium has started to fade, allowing carry and relative yield stories to regain influence.

That said, the Dollar remains highly sensitive to any deterioration in confidence. If negotiations stall, oil rises further, or markets question the durability of the ceasefire, the Dollar would not need much of a catalyst to recover its defensive bid.

Reports over the weekend suggested Iran has put forward a proposal to the US to reopen the Strait of Hormuz, linked to an extended ceasefire, a broader peace framework and later nuclear talks. Washington has not yet shown clear willingness to engage, leaving markets cautious rather than convinced.

GBP: Sterling supported by carry and BoE risk

Sterling closed last week firmer against most G10 peers, helped by stronger UK data and still-resilient risk sentiment. The familiar stickiness in Bank of England pricing has returned to focus ahead of this week’s policy decision.

With markets pricing a little more than two rate hikes by year-end and Bank Rate already at 3.75%, sterling continues to screen attractively from a carry perspective. That gives the pound room to benefit if the BoE leans even modestly hawkish.

The conflict backdrop has also been less damaging for sterling than for the euro. Investors appear to view the UK shock mainly as an inflation issue rather than a growth shock, reflecting lower direct exposure to imported energy than the eurozone.

We retain a mild upside bias for GBP/EUR, with 1.1560 (0.8650) in view. GBP/USD looks more balanced, with 1.35 a reasonable near-term anchor unless geopolitical conditions worsen materially.

EUR: Energy exposure keeps the single currency vulnerable

The euro has started the week on a cautious footing, with investors waiting for clearer signals from Washington before pricing a stronger de-escalation theme. After weeks of conflicting headlines, markets have become more willing to look through noise, but not enough to turn decisively constructive.

The euro remains particularly exposed while the Strait of Hormuz stays effectively shut and oil prices remain under upward pressure. The bloc’s dependence on imported energy, together with the memory of the 2022 energy shock, keeps investors wary of the medium-term growth outlook.

Even so, we do not expect the euro to return fully to March’s bearish tone while both sides still appear publicly committed to ending the conflict. The risk is time-sensitive. Each day without visible progress is likely to weigh further on sentiment, with the common currency increasingly acting as a proxy for the region’s energy vulnerability.

For EUR/USD, we expect the pair to hold above the 200-day moving average near 1.1680, although downside risks remain linked to geopolitics and the market’s reading of the Fed versus ECB policy mix.

Looking ahead

• Central bank meetings from the Fed, ECB and BoE are the key scheduled events this week.
• Guidance is likely to stay cautious and data-dependent, limiting the scope for sharp FX moves.
• A firmer inflation message from Powell versus Lagarde would likely support the Dollar, particularly if geopolitical uncertainty persists.
• Sterling should remain better supported than the euro if BoE pricing holds firm.
• Clear progress on reopening Hormuz would favour carry, weaken the Dollar’s defensive appeal and offer relief to the euro.