Market overview: Relief rally, but conviction remains thin

Markets started the week on a steadier footing as oil pulled back, risk sentiment improved and the broad dollar gave back some recent gains. Brent’s retreat was helped by reports that a small number of vessels are moving through the Strait of Hormuz, the release of emergency oil reserves and stronger export flows out of Saudi Arabia’s Yanbu port, which offers an alternative route to Hormuz. That combination helped cool immediate supply fears and encouraged a rebound in both equities and bonds.

Even so, this still looks more like a tactical reset than a decisive turn in sentiment. Price action remains highly reactive, with markets swinging sharply on each geopolitical update. Longer-run growth and inflation expectations have stayed relatively well anchored, but that has not prevented short-term moves from becoming increasingly disorderly as investors lurch between risk appetite and defensiveness.

The core issue has not changed. There is still no clear sign of de-escalation in the Gulf, and further strikes on regional energy infrastructure keep the threat to supply firmly in view. Markets are also watching whether Washington can build support for efforts to secure shipping routes, though the response from allies has so far been cautious. For now, war headlines and oil remain the key drivers, with broader macro themes taking a back seat.

USD: Dollar setback looks corrective, not decisive

The pullback in the DXY looks more like a pause than a reversal. After three straight daily gains, the index softened as oil prices fell and some immediate demand for safety ebbed. Even so, it remains close to the 100 level, and a move back above that threshold still looks plausible if conflict risk intensifies again.

The Fed should reinforce that underlying support. Wednesday’s meeting is unlikely to deliver a major policy shift, but the tone may lean firm. Recent messaging has shown a greater sensitivity to inflation risks, while the labour market appears to be stabilising rather than deteriorating. That leaves the Fed in a position to signal patience on easing, particularly if policymakers judge that softer recent data were at least partly distorted by temporary factors such as poor weather.

For the dollar, the mix remains supportive. Geopolitical stress, a cautious Fed and the inflationary implications of higher energy prices should keep the bias tilted to the upside, even if short-term positioning continues to generate sharp pullbacks.

GBP: Hawkish BoE repricing supports sterling, but only up to a point

Sterling has held up better than most European currencies as markets have aggressively revised the Bank of England path. What had been priced as around 50bp of easing this year has swung to a small amount of tightening, reflecting the view that the BoE is among the central banks most likely to respond forcefully if energy-driven inflation pressures build again. That repricing has helped lift GBP/EUR towards 1.16.

Still, the pound’s story is not uniformly constructive. Its softer performance against commodity-linked currencies suggests that policy repricing is only part of the picture. Terms of trade remain a key constraint, and that matters more in an environment where energy prices are again shaping the growth and inflation outlook.

That leaves sterling resilient, but not immune. GBP/USD has already slipped back below 1.33 and continues to struggle for sustained upside traction. If the energy shock fades, support should emerge in the low 1.30s. But if conflict persists and energy prices stay elevated, the pound’s external vulnerabilities could move back into sharper focus. Options markets are already reflecting that risk, with demand for downside sterling protection remaining pronounced, especially at shorter maturities.

EUR: Oil still matters more than rates

EUR/USD recovered modestly as oil prices eased, but the broader backdrop remains difficult. The pair briefly tested levels last seen in August 2025 near 1.14, and another move towards that area still looks feasible this week if crude turns higher again and the Fed delivers a firmer message.

For now, oil is doing more to shape EUR/USD than rate differentials. Higher energy prices tend to support the dollar mechanically because global oil trade remains heavily dollar-based, while the euro suffers both from that flow effect and from a weaker regional growth narrative. Hopes for a eurozone recovery in 2026, including optimism linked to German fiscal support, are vulnerable if the conflict drags on and energy costs remain under pressure.

That helps explain why a hawkish ECB has had limited FX impact. Markets already price a meaningful degree of tightening by year-end, so incremental shifts in ECB rhetoric carry less weight. By contrast, any hawkish adjustment from the Fed can still have a larger effect on the dollar. Even if the direct oil impulse softens, a more fragile eurozone growth outlook is likely to cap the euro’s recovery.

Looking ahead

• FOMC communication is the main scheduled event, with markets focused on whether the Fed signals a longer pause before easing later this year.

• Oil and Strait of Hormuz developments remain the dominant macro driver for FX.

• A renewed rise in crude would likely support the dollar, pressure EUR/USD and expose sterling’s energy sensitivity.

• Any credible progress on securing shipping flows could extend the current relief move in risk assets and weigh further on the dollar.

• In the near term, headline risk remains high and conviction across G10 FX is likely to stay light.