What happened in April?
FX markets reacted to ongoing uncertainty in the Middle East, but after making significant gains in March the dollar fell back.
Euro strengthens as ceasefire endures
The euro gained against the dollar in April, buoyed by the enduring ceasefire in the Middle East. The 1.5% gain was as much a product of a weakening dollar as it was of euro strength.
The pound benefits
Like the euro, sterling benefited from the fragile peace in the Middle East and the dollar’s broad-based weakness, strengthening by around 3% against its US counterpart in April.
The dollar dips
The dollar lost its lustre as a safe-haven asset in early April, though it recovered some of its value towards the end of the month.
What’s in store for May?
The pound
Investor sentiment continues to be shaped by events in the Middle East. An uneasy peace persists, but any return to hostilities could undermine the pound as investors seek safe-haven assets. The dollar and the euro are both considered better bets in times of intense volatility.
By contrast, a reopening of the Strait of Hormuz and a fall in oil prices could see sterling consolidate gains made in April. The Bank of England (BoE) maintained interest rates at 3.75% in April, but with oil prices continuing to drive inflationary pressure, a rate hike might not be far away.
The euro
The euro is in a similar boat to sterling, in that any return to hostilities in the Middle East would further highlight the vulnerability of Europe’s economy and undermine its currency. For now, the euro is being supported by the expectation that the European Central Bank (ECB) will turn to interest rate rises sooner rather than later as inflationary pressures mount. Headline inflation rose to 3% in April from 2.6% in March, with higher energy prices the main culprit.
The dollar
The dollar may rally in May if no lasting peace deal is reached between the US and Iran and the Strait of Hormuz remains closed, benefitting from its safe-haven status.
Focus will also be on the likely confirmation of Kevin Warsh as the next chairman of the Federal Reserve (Fed). Warsh, who could be sworn in on 15 May, is President Trump’s pick for the position and is considered to be more dovish than current chairman Jerome Powell. The dollar may weaken if investors believe Warsh will cut interest rates quickly this year, despite continuing inflationary pressures.
The takeaway?
Inevitably, all eyes remain fixed on the situation in the Middle East and the Strait of Hormuz as a global trade route. If energy prices rise further, inflationary pressures in the UK and Europe will make interest rate rises more likely, potentially strengthening European currencies against the dollar.
But the next moves by either the US and Iran are difficult to predict, making continued volatility highly likely.
