USD: Oil premium starts to unwind

Risk sentiment has improved after President Trump said overnight that the conflict with Iran could be resolved soon and that US military objectives were largely complete. That has helped reverse part of the weekend’s sharp move, with Brent falling back towards $90 per barrel after peaking at $113 on Monday. As the energy shock has eased, the dollar has softened and GBP/USD has extended its rebound to 1.3447.

Even so, markets remain cautious. European equities have opened higher, following gains in Asia and on Wall Street, while Brent has fallen more than 8% this morning. But the improvement still looks tentative. Reports of missile threats and drone interceptions continue to keep the Strait of Hormuz effectively closed, limiting the scope for a deeper pullback in energy prices. Oil volatility remains extreme, and Brent is still more than 50% higher year to date.

That matters for the dollar because the recent rally has been closely tied to the oil shock. Higher crude prices increase global demand for dollars through trade, funding and settlement channels, while also tightening liquidity and prompting a broader move into defensive USD positions. If tensions ease further, that dynamic should fade. Lower oil would reduce dollar demand, ease pressure on liquidity and shift focus back to macro data. In that context, Friday’s weak US jobs report and this week’s CPI release matter more. If inflation cools as growth softens, expectations for the Fed path could move lower and weigh on the dollar.

GBP: Sterling supported by rates repricing

Sterling has held up relatively well, helped by a sharp repricing in Bank of England expectations. The retreat in oil prices yesterday, after Brent briefly moved towards $120, helped unwind some of the aggressive hawkish shift that had challenged the BoE’s easing bias. Markets had earlier priced around 22bp of tightening by year-end before that fell back to roughly 3bp.

The front end of the gilt curve has reacted more sharply than other G10 markets to the inflation risk created by the conflict. That reflects both the UK’s exposure to higher crude prices and the policy backdrop. Inflation is still running at 3%, and the BoE has shown little urgency to accelerate easing, leaving short-dated UK yields especially sensitive to energy-driven inflation shocks.

That has helped limit sterling’s downside, particularly against the euro. GBP/EUR has risen roughly 1% since the conflict began on 27 February, with positioning also helping to cushion the pound. With no major UK events due today, sterling is likely to remain driven by geopolitical headlines. For now, the tone looks mildly supportive, with the pound also benefiting from a larger hawkish repricing in UK rates than in the euro area. GBP/EUR is trading at 1.1560 on Tuesday and, if sustained, would mark a fourth straight daily gain.

EUR: Energy shock still dominates

EUR/USD continues to make lower daily lows and remains below its 200-day moving average at 1.1674, although the rebound from four-month lows suggests some stabilisation is starting to emerge. The broader bias remains lower, but the pace of the decline has slowed.

The euro’s roughly 2% fall since the Middle East crisis began reflects both the stronger, oil-linked dollar and Europe’s vulnerability to higher energy costs. Those forces have outweighed any support from narrower US risk premia and continue to dominate the pair.

A more hawkish ECB is unlikely to offer much protection. The experience of the Ukraine shock showed that when Europe’s competitiveness is hit by rising energy costs, the euro tends to weaken regardless of rate expectations. For now, EUR/USD remains driven more by geopolitics and energy markets than by central bank rhetoric. Until there is a clearer improvement in Middle East conditions, the euro is likely to stay under pressure.

Looking ahead

• Middle East headlines remain the main near-term driver for FX

• Oil is still the key transmission channel for the dollar and broader risk sentiment

• US CPI is the next major test for the USD after last week’s weak payrolls report

• Sterling may stay relatively supported if UK rates continue to reprice more hawkishly than ECB expectations

• EUR/USD is unlikely to recover meaningfully until energy markets stabilise