De-escalation failed
The current dynamics of the foreign exchange market are shaped less by fundamental data and more by the gap between expectations and reality. Markets have already tried to price in a de-escalation scenario but quickly faced the fact that this scenario currently lacks sufficient confirmation.
De-escalation trade that didn't materialize
The initial reaction was typical. Following news of a possible truce, investors began to exit the dollar, rebuild positions in high-beta currencies, and return to carry strategies. This corresponded to a classic shift to a lower volatility environment and increased risk appetite.
However, this movement proved short-lived. The market quickly revised its expectations after new signals emerged that the conflict was far from over. Rhetoric about a possible continuation of hostilities for several more weeks, as well as statements about violations of the truce terms, returned the market to a risk-off mode.
The Strait of Hormuz as the center of the entire structure
The key factor around which the entire FX narrative is currently built is not the fact of a truce itself, but the issue of the functioning of the Strait of Hormuz. A significant portion of global energy flows passes through it, and its status determines the behavior of not only the oil market but also currencies.
Currently, there is no clarity regarding its full opening. There is no stable transit regime, and the risks of new restrictions or attacks remain high. This means that the energy premium does not disappear, and along with it, the general level of uncertainty persists.
It is this uncertainty that prevents the market from fully transitioning to risk-on, even despite formal signals of de-escalation.
Dollar: from correction to renewed support
The first stage of dollar weakening has already occurred, but it was more positional than structural. For this movement to continue, clearer signals of stabilization are needed – primarily regarding energy flows and geopolitical risks.
Instead, the market received a new wave of uncertainty, which brought back demand for the dollar as a safe-haven asset. In such conditions, the USD ceases to be merely a function of rates and once again begins to play the role of a risk management tool.
This means that without a real reduction in geopolitical tensions, any further dollar weakening will remain limited.
Macroeconomic background: secondary but important
Despite the dominance of geopolitics, the macroeconomic factor does not disappear. The Fed minutes highlighted the presence of two-sided risks, including the possibility of both faster policy easing in the event of a deteriorating labor market and the maintenance of a tighter stance.
The market has already adjusted expectations for rate cuts but remains sensitive to new data. Employment figures, in particular, are attracting attention, as they could shift the balance of expectations.
However, at the current stage, macro data play a secondary role: they can amplify movement, but not determine its direction. The direction is set by geopolitics.
EUR: stability without momentum
The euro shows relative stability due to tighter expectations regarding ECB policy. The market continues to price in a significant amount of rate hikes, and this "tightness" limits the currency's potential downside.
At the same time, the lack of full de-escalation does not allow the euro to move towards sustained growth. A drop to levels near 1.150 shows how quickly the market abandons optimistic scenarios in the event of deteriorating news background.
Thus, the euro remains in a position of relative strength, but without its own driver.
GBP: under pressure from rate reassessment
The pound appears more vulnerable in the current environment. Its sensitivity to risk and changes in expectations regarding Bank of England policy create additional pressure.
Comments by Andrew Bailey clearly signal that the market has likely overestimated the scale of future policy tightening. Given weaker price dynamics and limited risks of secondary inflation, there is room for lower rate expectations.
This forms an asymmetry in which GBP looks weaker relative to EUR.
Market of trust, not news
The most important characteristic of the current phase is the change in the object of trade. The market no longer reacts to the mere fact of news but assesses the likelihood of its realization.
A formal truce without an enforcement mechanism does not create a lasting effect. Any positive impulse quickly disappears if it is not supported by real changes in the environment.
That is why the initial movement against the dollar did not translate into a trend.
Current balance and scenarios
The market is at a point of uncertainty between two scenarios. The first involves real de-escalation, stabilization of energy flows, and a return to a risk-on environment. The second — a breakdown of agreements, further escalation, and increased demand for safe-haven assets.
At the moment, market behavior is more consistent with the second scenario.
Base case scenario
Dollar weakening cannot be a standalone process. It requires a fundamental reason in the form of reduced geopolitical tensions and stabilization of global risks.
Until this happens, any movements against the dollar remain corrective, not trend-driven.