Sterling moved higher on Friday and the euro nudged up modestly as markets scaled back immediate concern over the US-Iran conflict and refocused on relative interest-rate expectations rather than any domestic UK developments.
Foreign exchange levels at 06:56 ET (10:56 GMT) showed GBP/USD at 1.3429, up 0.16%, while EUR/USD was trading at 1.1433, up 0.03%.
"The dollar is seeing no benefits from this situation," said Francesco Pesole, FX strategist at ING. He said that the ebbing geopolitical risk has re-centered investor attention on rate differentials, adding that these differentials have moved against the dollar in some instances - such as versus the euro - because of revived hawkish expectations overseas.
Oil eased from the midweek spike, with Brent crude slipping back to $76 per barrel after briefly touching $80 on Wednesday. That pullback in oil helped drag short-term US yields lower even as reports indicated that the U.S. struck Iranian bridges and Iran threatened a fresh closure of the Strait of Hormuz.
Pesole cautioned that investors may be undervaluing the chance of another closure of the Strait of Hormuz and the potential for non-linear spikes in oil prices, and he described the balance of dollar risks as "on the upside" despite the current calm.
Market moves in short-term US rates reflected the calming risk tone. The two-year USD swap rate has given back roughly half of the roughly 10-basis-point jump recorded after the re-escalation. Markets are currently pricing in about 35 basis points of Federal Reserve tightening for December.
Friday's US economic calendar was light, with no scheduled Federal Open Market Committee speakers, leaving traders to await next week's events for fresh direction.
ING's team noted that the day's rise in sterling was not driven by any UK-specific fundamentals. Instead, they said, the move reflected broad dollar weakness that was present across major currencies. There was no significant UK data or new commentary from the Bank of England that acted as the principal driver of Friday's session.
On the euro front, Pesole pointed to a moderate re-tightening in EUR/USD short-term swap rate differentials prompted by the Middle East re-escalation - roughly a 10 basis point move in the two-year tenor. He noted that this spread remains around 50 basis points wider than its April peak but only about 15 basis points wider than where it stood before the recent conflict flare-up.
That repricing has supported heightened confidence in expectations for a September European Central Bank rate increase. Even so, ING warned there is limited room for EUR/USD to extend gains from the recent moves.
"The path for EUR/USD to come out stronger from this re-escalation is quite narrow," Pesole said. "We expect stabilisation today - with markets potentially wanting to wait for weekend clarity - but risks are of a retest of 1.140."
ING's baseline view is that the US dollar index (DXY) should remain broadly stable around current levels unless oil prices resume a stronger upward trajectory or markets sharply reprice the risk of disruption in the Strait of Hormuz.
According to the bank, a sustained break below 1.140 in EUR/USD or a renewed surge in Brent toward $80 and above would be necessary to materially alter its near-term dollar assessment.
Summary
Markets pared immediate geopolitical risk from the US-Iran tensions on Friday, allowing sterling and the euro to gain slightly as traders focused on interest-rate differentials. Brent crude retreated from a midweek $80 touch to around $76 per barrel, easing pressure on short-term US rates. ING strategists highlighted limited upside for EUR/USD and said the dollar's near-term path hinges on oil moves or a sudden repricing of Hormuz-related risk.
Key points
- GBP/USD rose to 1.3429, up 0.16% as of 06:56 ET (10:56 GMT); EUR/USD ticked up 0.03% to 1.1433.
- Brent crude fell back to $76/bbl after briefly reaching $80, helping pull front-end US rates down.
- Short-term rate repricing lifted confidence in a September ECB hike, but ING sees narrow upside for EUR/USD; 35bp of Fed tightening is priced in for December.
Risks and uncertainties
- Renewed disruption to the Strait of Hormuz could trigger a sharp spike in oil prices, which would affect energy markets and risk assets.
- A sustained move in Brent back toward $80 and above, or a break below 1.140 in EUR/USD, would require markets to re-evaluate near-term dollar and rate expectations, impacting FX and bond markets.
- Limited market catalysts on Friday mean direction could hinge on next week’s data and central bank commentary, creating short-term uncertainty for traders in FX and rates markets.