Firm Dollar Support

MACRO FRAME

The US and Iran have agreed to a framework deal to end their conflict, reopen the Strait of Hormuz, and move toward broader negotiations—though major issues (Lebanon conflict, nuclear program) are not fully resolved yet.

STOCK INDEX FUTURES

Equity index futures were mostly higher overnight a focus remains on the US-Iran negotiations and conflict in Lebanon. The US and Iran agreed to the creation of a mechanism to ensure the end of military operations in Lebanon, The Wall Street Journal reported. This came after Tehran closed the Strait of again over the weekend. Qatar and Pakistan said a line of communication between the US and Iran had been formed to avoid ensure safe passage for commercial vessels through the Strait. Oil prices fell further, although expectations of a hawkish shift in policy from the Fed are keeping treasury yields elevated. Money markets are fully priced for a Fed hike by October. Warsh’s statement explicitly attributed elevated inflation to “supply shocks that have driven price increases in certain sectors, including energy”. However, with Brent and WTI both continuing a decline that began when the deal was first announced, it directly undermines the primary inflation driver Warsh cited, which in turn could reduce the probability of the hikes and add to bullishness.

Watch point: The Fed’s recent policy meeting has led markets to expect a hike in October. However, a sustained drop in the price of oil could challenge some policymakers views of whether tightening could be necessary. Still, policy will stay higher for longer reinforces the case for selectively adding some defensive positioning alongside exposure to the ongoing tech‑led momentum.

CURRENCIES

US DOLLAR: The USD index is little changed at 100.83. The dollar retains firm support from a hawkish shift in Fed policy expectations and the strongest net long in dollar positions in over 16 months, according to the CFTC. The dollar is seemingly being driven more by rates and macro factors than geopolitical developments over the last couple of sessions, as falling oil prices and direct US-Iran talks would otherwise see a flight away from dollar safety. Still, ongoing geopolitical uncertainty and Iran’s willingness to close the Strait are limiting the downside to the dollar.

Nine policymakers expect the Fed Funds rate to move upwards by the end of the year, while median forecasts show PCE inflation expected to climb by around 90 bps from the March projection. It is likely to take weeks for tanker traffic to resume to pre-war levels, leaving risks to inflation pointed to the upside, offering the dollar support. Confirmation that shipping through the strait is reaching pre-war levels is likely to pressure the dollar, and ease some tightening expectations, though markets will generally have to wait for upcoming inflation data to get a better read on the outlook for Fed policy. However, as long as oil prices continue to drop, inflation expectations should fall as well.

Watch point: A durable peace agreement and drop in oil prices is likely to unwind expectations of Fed policy tightening, though the FOMC meeting presented a sharp reversal in recent market dynamics, with the dollar now finding stronger support against foreign currencies.

EURO: The euro is little changed at $1.1462. Traders continue to monitor geopolitical developments between the US and Iran, while a firmer dollar in recent days has limited the upside for the euro. The Fed’s hawkish hold led money markets to significantly reprice the rate outlook for the central bank, while policy expectations for the European Central Bank have been little changed. While the cease in hostilities lowers the geopolitical risk premium and oil prices, emerging second-round inflation effects from the conflict could impact ECB policy. Money markets expect one more rate hike from the ECB this year come October. For the ECB, policy is likely to remain biased upwards, though a continued easing in services inflation could dull some expectations of a move upwards. The euro is likely to benefit from risk-on flows away from the dollar, though increased expectations of Fed tightening, a sharp reversal from earlier dynamics, now offer fresh pressure against the euro.

Watch point: While a peace deal and restoration of oil flows through the Strait is likely to push back tightening expectations, the ECB remains biased upwards in its policy trajectory and traders should be watchful of another rate hike in the next two quarters.

BRITISH POUND: Sterling rose 0.28% to $1.3271 after initially dropping on the news that Prime Minister Starmer announced his resignation and opened a leadership race that has highlighted focus on candidates plans for the economy. While initial price action has been relatively contained markets remain highly sensitive to fiscal credibility, particularly given the UK’s elevated borrowing costs and structurally weak growth backdrop. For now, the rate backdrop is likely to be the significant driver in price action for the pound. The Bank of England recently held rates steady in a 7-2 vote and Governor Andrew Bailey’s message was that it remains too early to call off the inflation risk. Looking ahead, the bar for further tightening appears high and contingent on renewed energy or expectations, while a sustained easing in inflation and confirmation of a softer labor market would keep the debate focused on how long policy must stay restrictive rather than any tightening.

JAPANESE YEN: The yen fell to 161.75 yen per dollar, fully reversing all of its gains from prior intervention in April. Fed pricing toward tighter policy, persistent rate differentials against Japan, and the lack of effectiveness of prior interventions without a sound Bank of Japan backdrop all continue to pressure the currency. Despite Japan’s Ministry of Finance signaling willingness to intervene, market skepticism of that effectiveness, largely resulting in a intervention vs. hawkish Fed and strong US data trade.

The BoJ’s recent rate hike offered the yen no support despite rates being at their highest level in 31 years. With policy rates in Japan still deeply negative in real terms, incremental moves are unlikely to deliver a durable yen rebound. Instead, markets are increasingly focused on Japan’s heavy debt load, while political support for a weaker yen, equity benefits from FX depreciation, and reluctance to tackle the debt overhang suggest any sustained yen strength will require more than rate hikes alone. The market sees a total of 23 bps of tightening by year-end. The yen has now sustained a break above the 160 support level.

Watch point: With the yen sustaining a break above the 160 level, intervention from the government appears to be the greatest near-term risk against further depreciation. Without intervention, the yen is likely to weaken against major peers.

AUSTRALIAN DOLLAR: The Aussie is little changed at $0.7007. Recent pressure against the Aussie has come from stronger Fed rate hike pricing, which has led to a compression in interest rate differentials. Stil, progress in US-Iran talks are largely supportive of the risk-sensitive currency. Markets are pricing around a 65% probability of another hike from the Reserve Bank of Australia this year. The Bias for the RBA remains toward further tightening as the bank is seen as having a lower threshold to hike again, particularly if inflation continues to surprise to the upside and if growth and labor data continue to prove resilient. CPI data on Wednesday and Labor data on Thursday will be key watch items for the path of AUD and the trajectory of the RBA. If both data sets surprise to the upside, a hike from the RBA is likely. Downside surprises are likely to null any expectations of RBA tightening.

Watch point: While a durable end to the war would alleviate downside risks to growth and moderate inflation pressures, ongoing pass-through into broader prices is likely to keep the RBA on a tightening path.

TREASURY FUTURES

Yields moved higher across the curve despite the drop in oil prices overnight as Fed repricing offers support for higher yields, while Bank of America Global Research said they now expect 75bps of tightening by year-end, compared to their prior call of no rate hikes. The views of the sharp shift in hawkishness are driven by resilient economic data, sticky inflation, and a perceived hawkish reaction from Chair Warsh. The BofA forecast is notably more hawkish than consensus market pricing of around 42bps of hikes in 2026. The BofA is among a minority of firms calling for additional tightening by year end. Still, the recent Fed meeting has reinforced upward pressure on front-end yields, which has significantly compressed the 2/10 spread to 27 bps from 40 bps seven days ago. The key tension remains a more hawkish Fed reaction function and market pricing, leaving Treasuries vulnerable to further repricing if incoming data supports the Fed’s tightening bias. Warsh characterized the inflation overshoot as supply-driven rather than demand-driven, leaving room for yields to eventually ease if oil prices continue to hold a substantial drop.

Watch point: The Warsh-led Fed held on rates and signaled broad institutional change. Mainly, markets should expect fewer words from the Fed and less policy signaling, raising near-term rate volatility with incoming data.

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