US Dollar: Geopolitics faded as markets eye rates – ING

ING’s Francesco Pesole notes the US Dollar (USD) has been broadly unchanged despite renewed Middle East tensions, as Oil has retraced and risk sentiment improved. He highlights that fading geopolitical risk keeps focus on front-end rate differentials, which have moved against the Dollar in some cases. ING sees upside risks for the Dollar but expects only limited DXY reaction if Oil stays contained.

Dollar sidelined by rate focus

"Markets are taking a decisively optimistic stance on fresh US-Iran tensions. Multiple reports indicate traffic in Hormuz has dropped to almost zero in the past couple of days, and we have seen effectively no intent of de-escalation from either party."

"The 2-year USD swap rate has erased roughly half of the 10bp jump after the re-escalation – 35bp of tightening is currently priced in for December."

"The dollar is seeing no benefits from this situation. Fading geopolitical risk means continuous focus on rate differentials, which have moved against USD in some instances (e.g., vs the euro) by revamping hawkish expectations abroad."

"Incidentally, the recovery in risk sentiment yesterday prompted a decent rebound in high-yielding EM FX after an unwinding of carry trades earlier this week."

"The risks here are obvious. Investors may be underestimating the chance of a new Strait of Hormuz closure and non-linear oil spikes. The balance of risks remains on the upside for the dollar, although only a modest pick-up in oil prices and markets rapidly turning to headline fatigue would probably leave DXY pretty much where it is now."