Amid a mix of messages and a case of “will they, won’t they” on US-Iran talks, the dollar has been caught in a bit of limbo in the past week. At the balance, the currency is still lower amid the risk rebound since the start of April. That comes as broader markets are pricing in stronger odds of a more optimistic outcome to the conflict.
In essence, traders and investors are moving in a direction that sees peak tensions firmly in the rearview mirror. And they are banking on the hope that eventually there will be good news to vindicate turning a blind eye towards the fact that the Strait of Hormuz will be closed for nearly nine weeks now.
The dollar also fell as a result of the hopeful optimism but further gains have been limited in trading this week. So, what gives?
BofA argues that the dollar retreat in part also reflects some seasonal flows and that could reverse in May, all else being equal.
“Markets continue to move beyond peak conflict conditions. Broader measures of FX volatility and skew continue to revert towards pre-conflict levels and the BBDXY, SPX and VVIX have retraced levels relative to respective ranges since 27 February on the belief that negotiations limit the risk for further near-term escalation. Whether this calculation proves correct remains to be seen, but we do think that the USD reversal through April has, in part been driven by seasonal factors. Using a 15-year window, April is the most negative seasonal month for USD performance.
For this reason, remain wary that USD underperformance can extend at its current pace: as much as April is the most negative month for USD performance, May is the second most positive for BBDXY performance. We continue to maintain a core long USD position versus both CAD (via options) and GBP (in spot) heading into May.
Key to this view is that whilst FX and equities have mean reverted, both oil prices and bond yields remain elevated relative to the range from February.”
On the other hand, Barclays is arguing that the dollar remains more trapped in a more bearish environment in the big picture. And as such, the firm expects the greenback to show some continued weakness in the short-term.
“Amid market pessimism around the tensions in the Middle East, the dollar’s performance was underwhelming against shocks that should have otherwise boosted it significantly. The reduction in regional pressures should, thus, drive the dollar weaker and we set EUR/USD at 1.18 as a three-month forecast on that basis. Dollar price action, this year, has been dominated by geopolitical risks and USD vs G10 and USD vs EM negative correlation with risk sentiment has been re-established.
This past week saw a number of asset markets rush to fade the risk premia from the Middle East tensions. EUR/USD recovered back to pre-war levels and fully to our 1.18 three-month forecast. Tactical prudence would argue that price has extended significantly, while risks have yet to fully dissipate. In that sense, tactics would likely point to some risks for dollar retracement near term.”
