Monetary policy in Europe and the US may be diverging, with the US (perhaps surprisingly) looking to take a more hawkish stance. The difference could spur money market volatility.
The dollar enjoyed another strong week, pushing both the pound and euro to multi-month lows. The US currency is benefitting from continued uncertainty in the Middle East, despite the fragile peace agreement reached between the US and Iran, and the broad-based resilience of the US economy.
Trade has started to flow again through the Strait of Hormuz. Brent crude oil has fallen back to levels last seen before the conflict began, reflecting growing confidence in the peace process, though the physical recovery in supply remains incomplete with Persian Gulf exports still running at around 75% of pre-war levels and the Strait requiring further clearance of mines.
Could the dollar go higher?
There is a real possibility that the dollar’s momentum will continue. That’s partly based on economic fundamentals, and partly on the more hawkish sentiment now emerging from the Federal Reserve (Fed). Markets are forecasting US interest rate hikes later in the year, though how far they will go is open to question. Rising interest rates tend to bolster currencies by making them more attractive to investors.
By contrast, the European Central Bank (ECB) raised interest rates by 25bps in June in line with expectations, but ECB President Lagarde appeared to downplay the likelihood of further hikes in the short term. The Bank of England (BoE) held interest rates steady at 3.75% in June for the fourth month in a row, and will probably do so again in July. Both central banks are looking to see how the impacts of the war in Iran play out over the summer but markets are reigning back expectations of further rate increases in the short term.
The week ahead
Markets will be looking for any sign of rising tensions in the Gulf, where the peace agreement is just about holding despite provocations from both sides. Elsewhere, investors will be looking at consumer confidence and economic sentiment data (Monday) as well as inflation figures across the bloc (Tuesday and Wednesday). In the US, manufacturing PMI (a measure of confidence based on business surveys – Wednesday) and jobs data (Thursday) take centre stage, while house prices (Tuesday) will be the focus in the UK this week.
