Investors Take Israel-Iran Conflict in Stride: Gold, Oil, and the Dollar are Softer

[Redator]

Overview:  After inflicting damage on Iran's proxies (Hamas and Hezbollah), Israel turned to Iran itself following the IAEA's finding that Tehran was in violation of its uranium-enrichment targets. The war continues. The US reportedly helped Israel shoot down missiles aimed at it, but so far Russia, which signed a defense pact with Iran earlier this year has been restrained, as has China, the biggest buyer of Iranian oil. The markets' response will be studied for some time. It is not just the greenback, which seems to have mostly ignored the geopolitical developments, but gold and oil are lower, and stocks are higher. The US dollar is softer against the G10 currencies, but the Swiss franc and Japanese yen are nursing minor losses. Among emerging market currencies that are trading, only the Thai baht and Philippine peso are softer. 

Japanese and South Korean equities led Asia Pacific bourses higher today. Among the large markets, only Taiwan and Singapore did not participate in today's advance, though we note that the Taiwanese dollar rose to a new three-year high. Europe's Stoxx 600, which fell in every session last week, is about 0.25% higher today. US index futures are 0.4%-0.5% higher. Benchmark 10-year yields are mostly 1-3 bp higher in Europe, and the 10-year US Treasury yield is up nearly four basis points to 4.43%. Gold initially extended last week's gains. It poked above $3451 before selling pushed it below $3410. It has steadied near $3416. August WTI gapped higher to $75.50 but has been sold back to around $70.60. 

USD: Israel's attack on Iran lifted the dollar ahead of the weekend, but it barely rose above the previous session's high. It is trading softer today, but inside last Friday's range. It is straddling the 98.00-level in Europe. The geopolitical tensions could not offset the weakening of the US brand. Despite the pre-weekend gains, the Dollar Index settled about 1% lower on the week and posted its second lowest close in a little more than three years. The greenback was battered last week, squeezed by softer price pressures, lower rates, and warning that President Trump will send letters detailing new bilateral tariffs under the so-called "reciprocal tariffs."  It is a second "liberation day" of sorts. He also is threatening to hike the 25% auto tariff, and the budget contains a provision to punish companies operating in the US who, for example, adopt the OECD corporate tax reform that the previous US government helped negotiate. Wednesday's FOMC meeting is the highlight. Although hold rates steady, Fed Chair Powell's comments and the updated Summary of Economic Projections are the key. Fed officials have played down the importance of the survey data, and that will help minimize the impact of today's Empire State survey.

EURO: The euro held within Thursday's range (~$1.1485-$1.1630) amid the setback on before the weekend on the geopolitical developments. It is in a roughly $1.1525-$1.1590 range today. The price action suggests buying on pullbacks is still the preferred strategy. Eurozone labor costs in Q1 slowed to 3.4% from 3.8% in Q4 25. The trajectory is lower. Last week, the ECB projected wage growth to slow to 1.7% in Q4 25 from 5.4% in 2024. Wage growth is projected to slow more next year. While this may lift official confidence in sustaining the inflation target, the risk is for a downside overshoot, and weaker wage growth may crimp consumption.

CNY: The dollar settled last week near the middle of the consolidative range we see roughly between CNH7.16 and CNH7.2260. It is striking that the changes in the dollar-offshore yuan and Dollar Index correlation are near 0.12 over the past 30 sessions. The rolling 60-day correlation was near 0.75 at the start of the year and now it is a little above 0.20. It is trading quietly today (~CNH7.1790-CNH7.1905). The PBOC set the dollar's reference rate higher for the first time in five sessions today (CNY7.1789 vs. CNY7.1772 before the weekend). China's May macro data was mixed. Retail sales ticked up on a year-to-date year-over year basis, but it is minor (5.0% vs. 4.7%). By the same metric, industrial production was slowed slightly (6.3% vs. 6.4%). House prices (new and used) continue to bleed lower, and property investment continues to contract. The surveyed unemployment rate was slipped to 5.0% from 5.1%. US Treasury Secretary Bessent recently repeated that China cannot export its way to prosperity. This represents a common misunderstanding of the challenge China represents. China's exports as a percentage of GDP are quite modest at a little less than 20% in 2023 (the most recent comprehensive data), which puts it at the lower end of the G20 countries. The real challenge comes from the scale given the size of the economy. 

JPY:  The dollar initially approached the lower end of the recent range ahead of the weekend (~JPY142.80 vs. JPY142.40-60). It recovered to almost JPY144.50 in North America. It reached JPY144.75 in early trading today before backing off to find support near JPY144.00. As we noted, the exchange rate's correlation with US rates as also recovered in recent weeks and US yields jumped before the weekend. The BOJ meeting concludes tomorrow. BOJ Governor Ueda's rhetoric has softened. Last week he cited "distance" from the inflation target. He recognized that monetary policy is still not in a position to help support the economy, i.e., he played down the possibility of a rate cut to aid for the economy. Rather than rates, the focus is on the BOJ's balance sheet and the amount of government bonds it purchases. As of the end of Q1, the BOJ's balance sheet was 118.2% of GDP, down from 127.2% in March 2024 and 129.6% the end of March 2023. At the same time, the Fed's balance sheet has fallen to 22.7% of GDP at the end of Q1 25 from 26.5% at the end of Q1 24 and 32.7% at the end of Q1 23.

GBP: Sterling posted an outside day ahead of the weekend by trading on both sides of Thursday's range but the close was well within the range. It is trading sideways today (~$1.3535-$1.3595). As we suggested with the euro, so too with sterling: buying on pullbacks remain evident, suggesting the bullish sentiment remains intact. A larger than expected April economic contraction did not prevent sterling from reaching new three-year highs last week near $1.3630. The next technical area of note is $1.3640-$1.3700. Today's Rightmove house price index for edged slightly lower (-0.3% June after it rose 0.6% in May) but is not the focus. Wednesday, the UK reports May CPI, which is likely to steady after the 1.2% utility-led surge in April. Still, there is little chance of a BOE rate cut the following day. Yet, the odds of a cut at the next meeting (August 7) have risen to around an 80% chance from about 65% a week ago.

CAD: The US dollar fell to a new eight-month low near midday in NY before the weekend near CAD1.3565. It is pinned today near the lows. It has not been much above C AD1.3600 today and has been pressed to CAD1.3570 in Europe. Provided the CAD1.3730-50 cap remains intact, there greenback appears to be headed toward CAD1.3400, though the CAD1.3500 area may offer psychological support. Given the broader context, today's May housing starts are unlikely to have much impact on the Canadian dollar. This week's data highlights come later in the week with the April portfolio flows and retail sales, which also seem unlikely to capture the market's attention for long.

AUD: The Australian dollar recovered from a seven-day low that it reached on the initial news of Israel's strike (~$0.6455) to almost $0.6520 near midday in NY before the weekend. It pulled back to around $0.6460 where new buying emerged. It is firmer today and set session highs in European turnover near $0.6515. Key resistance remains in the $0.6540-50 area. The week's data highlight is Thursday's employment report. After employment rose by nearly 90k in April, job growth is expected to slow to around 20k in May. Still, job growth in Australia is not far off last year's pace. The average in the first four months of the year was about 26k compared with 31k in the Jan-April 2024 period. 

MXN: The dollar spiked to about MXN19.08 on the initial reports of Israel's strike. It made a new marginal high a little above MXN19.10 in early North American turnover before it retreated to around MXN18.8860. It consolidated mostly below MXN18.95 in the North American afternoon ahead of the weekend. The dollar has unwound most of its gains and is trading in a MXN18.8825-MXN18.9760 range today. It in on its lows in late European morning turnover. There does not appear to be market-moving data from Mexico this week. However, elsewhere in Latam, the central bank of Chile is seen retaining its 5.0% overnight rate target on Wednesday, and after hiking rates aggressively, Brazil's central bank may be content as price pressures have begun softening. 

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