MUFG: The USD

It has been a quiet start to the week for G10 currencies with the US dollar continuing to trade close to year-to-date highs. 80. One of the biggest movers overnight has been the price of oil which has risen back up towards recent highs at around USD110/barrel. It reflects some disappointment over the lack of progress towards a deal to end the US-lran conflict and re-open the Strait of Hormuz.

Bloomberg has reported over the weekend that Iran is sticking to its seven-day proposal for re-opening the Strait and won’t soften its conditions. While US President Trump has sent mixed signals about his willingness to reach a deal. He told Axios that he expects negotiations to resume this week even though he rejected Iran’s latest proposals. US and Iranian negotiators have reportedly been exploring a deal that would see Tehran reopen the Strait and Washington lift the blockade of Iranian ports.

At the same time, Saudi Arabi’s capital came up attack from Houthi militants in Yemen on Saturday. Saudi-backed coalition forces in Yemen said air defences intercepted two drones launched by the Houthis toward Riyadh. Higher energy prices for longer have been a key driver of the sell-off in global bond markets since the summer, with the major central banks including the Fed no longer willing to look through the energy price shock.

After delivering their first hike this month, the US rate market now expects the Fed to deliver almost another 100bps of rate hikes in the year ahead which is reinforcing support for the US dollar from the positive terms of trade shock for the US economy from higher energy prices. The release of stronger US economic data over the past week has added to the impression the US economy is better able to withstand higher interest rates as well. On the other hand, US Treasury Secretary Scott Bessent has urged the Fed over the weekend to keep an “open mind" on the US inflation outlook.

He stated that Fed Chair Kevin Warsh is "well aware” that the US economy is seeing gains similar to "if not more substantial" than when Alan Green Greenspan was Fed chair during the 1990's internet boom. He noted that Alan Greenspan had "let things run" and the Fed should have an open mind because, again, it's the deregulatory aspect. However, recent hawkish comments from Fed officials have indicated that they are not currently attaching a lot of weight to the potentially disinflationary impact from Al-related productivity gains when setting policy. The current backdrop is supportive of the US dollar remaining stronger for longer.