Following the initial moves on Monday, FX markets have been relatively subdued so far this week.
This likely reflects that a large degree of the risk was already priced in and the notion that geopolitical shocks tend to cause only temporary market disruptions. The fact that the attacks occurred at the weekend while markets were closed has also likely helped contain things and limited any immediate knee-jerk reactions.
That said, the conflict has been broadening this week and we’ve not seen much in the last few days to suggest that a short, sharp conflict is in store. The US and Israel have been carrying out sustained air campaigns, while Iran has been responding with missile and drone attacks targeting Israeli and US assets across the Middle East, including in the UAE, Kuwait and Saudi Arabia.
President Trump has suggested that military operations could last four to five weeks, while Iran’s foreign minister has indicated there is “no limit” to the country’s right to self-defence. Polymarket is now assigning only around a 30% chance of an end to US military operations by the end of March, which is down from more than 80% in the immediate aftermath of Saturday ’s attack.
Clearly among the main implications of the war is the fallout in oil. Brent crude oil prices have continued to rise this week and are up by over 5% today to $88 a barrel level from the $70 mark. Iran’s effective blockade of the Strait of Hormuz has reduced vessel traffic by around 90%. If the disruption persists, a move toward $100 per barrel cannot be ruled out.
Where we go from here will be highly dependent on the length of the conflict. There are many factors that could affect this but the extent of the depletion in Iranian missiles/drones might decide the speed of de-escalation from the Iranian side. From the US side, the level of political and market pressure Trump receives from home (given the upcoming midterm elections) could be key for deciding how long he wishes to continue fighting.
For now, markets appear to be pricing a conflict lasting several weeks. As long as that assumption holds, and barring any more bad news, further USD gains may be relatively limited. However, a broader regional escalation and a prolonged closure of the Strait of Hormuz would no doubt create further risk aversion and therefore exacerbate the market reactions we’ve seen this week (i.e. higher oil prices, a stronger USD, and a sell-off in perceived ‘riskier' currencies (e.g. EUR and GBP)).
As a result, the GBP/USD trades around 1.8% lower than last week’s high and around half a cent off Tuesday’s low (which was a 10-week low). The Euro has weakened a lot this week (mainly due to their heavy reliance on LNG) with the GBP/EUR trading around 1.2% higher this week (a 1-mth high) and the EUR/USD down over 2% this week (trading around a 3-mth low).
