Market overview

FX markets are trading with a cautious bias, as investors continue to price a degree of geopolitical relief before any durable de-escalation has been confirmed. The dollar remains supported, but not aggressively so, with softer Treasury yields and lower oil prices limiting fresh upside. That leaves G10 FX in a holding pattern, where currencies are reacting more to shifting headlines around the Strait of Hormuz than to a clear macro trend.

The fall in crude has helped ease pressure on high-beta and energy-sensitive currencies, while reducing the immediate inflation impulse that had been feeding into rate expectations. Even so, oil remains elevated enough to keep central banks wary and prevent markets from fully embracing a weaker-dollar narrative. For now, FX is caught between two competing forces: relief that energy prices have eased and caution that any renewed escalation would quickly revive USD haven demand.

The broader cross-asset backdrop still matters. With the 10-year Treasury yield sitting close to the S&P 500 earnings yield, equities are once again being forced to compete directly with bonds for capital. That keeps financial conditions tight and makes risk appetite vulnerable if yields push back towards the 4.5% to 5.0% area.

This is not a repeat of 2022. The dollar is supported, but the response has been far less forceful than in the last major oil shock. The adjustment is instead being spread across term premia, equity valuations, foreign rate expectations and hedging demand. The result is a market where bonds remain highly sensitive to energy prices, equities look vulnerable as yields move higher, and FX remains defensive rather than disorderly.

USD: Firm support, softer impulse

The dollar continues to benefit from a favourable mix of safe-haven demand, resilient US growth and a Fed path that markets are reluctant to loosen. Escalation in the Gulf would likely reinforce USD demand through higher energy prices and risk aversion, but even a diplomatic breakthrough may not be clearly dollar-negative if US data remain firm.

The key shift is that USD strength is no longer being driven purely by front-end rate divergence. Oil is now working through a broader financial conditions channel, lifting term premia and challenging equity valuations. That should keep the greenback underpinned, but the upside may stay more measured than the level of US yields would normally imply.

GBP: Sterling loses momentum as risks return

Sterling’s recent resilience is beginning to fade. GBP/USD has drifted back from recent highs, while GBP/EUR has struggled to sustain gains near 1.16, leaving the pound exposed to both external risk and domestic uncertainty.

The breakdown in US-Iran momentum is central to the shift. Any renewed stress in the Strait of Hormuz would risk reviving dollar haven demand and pushing Fed expectations more hawkish, both of which would weigh on GBP/USD. The narrowing UK-US 2-year yield spread already points in that direction.

Domestic politics are also becoming harder to ignore. The coming by-election could open the door to a longer leadership contest, keeping investors cautious. Options markets are sending a similar signal, with risk reversals showing stronger demand for downside GBP protection.

Technically, GBP/USD remains supported above 1.33, but rallies look capped into the 1.35 to 1.36 area. A break below 1.3250 would weaken the recovery story and bring the April low near 1.3160 back into view. GBP/EUR remains broadly constructive while above 1.1460 to 1.1480, but failure to clear 1.1600 leaves the pair range-bound and fragile.

EUR: Rate differentials regain control

EUR/USD is becoming less responsive to swings in headline risk and more sensitive to rate spreads. The pair’s fall from the 1.18 area in early May reflected a combination of hawkish Fed repricing and a less one-sided ECB pricing backdrop.

With markets now pricing a more balanced relative adjustment, EUR/USD has settled near the 1.16 lows. The pair lacks a decisive bearish catalyst, but it has also failed to regain key moving averages, leaving momentum muted.

Inflation now becomes the near-term trigger. Eurozone data and the US PCE deflator will be watched closely. A stronger US inflation print, especially without meaningful progress on Hormuz, would support a renewed test of 1.16. Christopher Waller’s hawkish comments may also receive greater attention if inflation surprises to the upside, creating a cleaner downside risk for EUR/USD.

Looking ahead

• US PCE is the key macro event for dollar direction and Fed pricing.
• Eurozone inflation will test whether EUR/USD can stabilise above 1.16.
• Oil remains the main cross-asset risk, with markets still pricing more calm than confirmation.
• GBP/USD downside risk increases below 1.3250, while 1.3480 is the first level bulls need to reclaim.
• GBP/EUR needs a clean break above 1.1600 to restore upside momentum.