A decisive week lies ahead. What are the scenarios for DXY?
The US dollar continues to consolidate near its highest levels since the escalation of the conflict in the Middle East in late February. According to MUFG analysts, the coming week could be an important turning point for the American currency, as markets will closely monitor both developments surrounding a potential deal between the US and Iran, and the first Federal Reserve meeting under new chairman Kevin Warsh.
Growing optimism about a possible cessation of the conflict and the opening of the Strait of Hormuz is already beginning to influence investor sentiment. If a deal is reached in the near future, it could weaken demand for the dollar as a safe-haven asset and contribute to a further decline in energy prices.
The Fed meeting is also drawing additional attention, as it is expected to provide markets with a better understanding of how the American regulator will react to the energy shock. If the new chairman demonstrates a willingness not to overreact to a temporary acceleration in inflation due to high oil prices, it could put further pressure on the dollar. Conversely, signals of potential rate hikes could support further strengthening of the American currency.
Dollar Remains Strong Ahead of Fed Meeting
The American currency strengthened after the release of a strong May employment report. A third consecutive month of robust job growth eased concerns about a slowing labor market and weakened arguments for rapid monetary policy easing.
Against this backdrop, markets are increasingly re-evaluating their expectations for future Fed actions. Yields on US government bonds rose faster than in most other developed economies, contributing to a widening interest rate differential in favor of the dollar.
Recent macroeconomic data from the US also largely exceeded forecasts for both economic activity and inflation. This strengthens expectations for a more hawkish rhetoric from the Fed at the upcoming meeting.
After three Fed officials immediately expressed disagreement with the previous dovish tilt at the April meeting, the market expects the regulator to refrain from signaling a possible rate cut in the near future. Updated economic forecasts may also show less support for a scenario of further policy easing.
Focus on Kevin Warsh's First Meeting
The main intrigue remains how the Fed's rhetoric will change after the change in leadership.
There is a widespread belief in the market that Kevin Warsh will be inclined to view the energy shock as a temporary factor and will pay more attention to structural disinflationary trends, particularly productivity growth. Such an approach would allow the Fed to keep open the possibility of rate cuts after the situation in energy markets stabilizes.
MUFG continues to expect the next step by the Fed to be a rate cut, not a hike. Accordingly, the bank maintains its forecast for a gradual weakening of the US dollar until 2027.
However, Warsh's first press conference will be an important test for this scenario. If the new Fed chairman signals that the regulator is prepared to consider rate hikes in response to inflationary pressures, it could pave the way for further dollar strengthening.
Potential US-Iran Deal Could Change the Situation
Towards the end of the week, expectations of a possible resolution to the conflict between the US and Iran and the reopening of the Strait of Hormuz intensified in the market.
Reports of a possible memorandum signing in the coming days contributed to a decline in oil prices, which returned to the $80 per barrel range.
Resumption of energy supplies from the region could ease inflationary pressure in the global economy and provide central banks with more leeway. For the dollar, this would mean losing some of the support it received from high energy prices and elevated geopolitical risks.
Concurrently, a correction is underway in commodity markets. The Bloomberg Commodity Index has fallen by more than 10% from its May highs, negatively impacting the currencies of commodity-exporting countries, including the Norwegian krone, and the Canadian and Australian dollars.
Furthermore, the stabilization of the situation in the Middle East could create more favorable conditions for the return of carry trade strategies due to reduced market volatility.
Bank of Japan Prepares for Rate Hike
The Bank of Japan will also be in the investors' spotlight. The regulator is expected to raise the interest rate by 25 basis points, continuing its course towards gradual monetary policy normalization.
A decrease in energy prices, if the Strait of Hormuz reopens, could further support this process and reduce pressure on the Japanese currency.
Despite reports of health issues concerning Bank of Japan Governor Ueda, markets do not expect any changes in the rate decision itself. However, a change in the speaker at the press conference could affect the market's interpretation of the regulator's signals.
The base scenario assumes further gradual policy tightening, provided that the economy develops according to forecasts. Another rate hike by the end of the year remains the most likely option.
However, a significant portion of this scenario is already priced into the market, so the potential for yen strengthening remains limited. If the USD/JPY exchange rate continues to move above 160, Japanese authorities may intensify verbal interventions to curb further weakening of the national currency.