Good morning. The dollar is flat, Treasury yields are edging lower across the curve, and oil prices continue to decline as traders await details of the US-Iran peace deal ahead of its signing on Friday and brace for turbulence around tomorrow’s Federal Reserve decision. Brent crude is changing hands at $81 a barrel and West Texas Intermediate at $78, with both benchmarks down nearly 11% this month.
Currency market reaction to the weekend’s ceasefire agreement has been surprisingly muted, with most major pairs moving less than a third of a percent since the news broke. To some extent, this reflects uncertainty in the energy complex: observed traffic through the Strait of Hormuz remains near zero, the reopening process promises to be gradual, and the inventory resupply needed to normalise global markets could keep prices elevated for some time. Iranian and American sources are also characterising the deal in starkly different terms, particularly over who will control the strait, leaving traders unsure how much of the energy-price shock will actually unwind.
But the calm also reflects markets that had already de-risked. After weeks of uncertainty reduced positioning excesses, there’s been no major unwind in directional trades. With the geopolitical noise fading, focus is shifting back to fundamentals, with relative growth, inflation and policy expectations once again helping differentiate currencies—and for now, those fundamentals continue to underpin the dollar.
The yen and Japanese government bond yields are little changed after the Bank of Japan raised its benchmark policy rate to 1%, the highest since 1995. In a well-telegraphed decision, officials cited inflation risks stemming from the war in the Middle East and pointed to evidence of a virtuous cycle in wages and prices as justification for tighter policy, but dropped a reference to borrowing costs being “significantly low” — suggesting interest rates are approaching neutral. Traders expect the pace of normalisation to remain slow—with the next hike not priced in until early next year—meaning the currency is likely to remain a preferred funding vehicle for now, forcing Japanese authorities to keep the threat of intervention on the table.
The Australian dollar is also holding steady after the Reserve Bank kept its cash rate at 4.35%, pausing after three consecutive rises earlier in the year. Officials warned that inflation remained too high and pledged to do whatever was necessary to bring it down, including raising rates further if required. But the economic backdrop is softening: growth slowed to just 0.3% in the first quarter as consumers pulled back, and the unemployment rate hit a four-and-a-half-year high of 4.5%. Markets are placing coin-toss odds on another hike by year-end—a step down from the near-certainty priced in earlier this year, and one that is eroding the improvement in real rate differentials that helped lift the Australian dollar in the first quarter. That fading yield support could cap the currency’s gains ahead.
Tomorrow’s Federal Reserve decision, in contrast, looms as a potential volatility catalyst. The committee is widely expected to keep its benchmark rate in the 3.50%–3.75% range and signal a shift to a neutral policy bias as policymakers grapple with elevated inflation risks. But uncertainty around the communications strategy is unusually high.
A dovish outcome is possible. Newly-installed Chair Kevin Warsh may choose to characterise the current inflationary overshoot as a temporary, commodity-led phenomenon—meeting President Trump’s expectations as he jawbones markets away from pricing a rate hike by early next year. We think he could keep his remarks deliberately cautious, seeking to avoid generating volatility at a moment when inflation expectations have already fallen sharply and investors are betting the Iran-driven energy-price shock will wash out.
But hawkish risks are also present. The US economy continues to generate stronger demand than its global counterparts, keeping job growth above expectations and underlying inflation pressures elevated. The Fed’s updated projections may reflect greater confidence in the labour market and greater concern on prices than officials signalled in March, and with Trump appointee Stephen Miran now off the committee, the ‘dot plot’ could skew substantially more hawkish. A majority of policymakers may pencil in rates on hold all year, with a small contingent expecting a move higher.
Since last week’s breakthrough in peace negotiations, monetary tightening expectations have fallen further in relative terms in the United Kingdom, the euro area and Japan than in the United States—tilting interest differentials in the dollar’s favour. Tomorrow’s decision could reinforce that trend—or, if Warsh strikes a dovish tone and demonstrates a capacity for influencing other committee members—begin to unwind it.
