ING FX Daily - FJElite

Higher beta and carry currencies have led the rebound against the dollar since the ceasefire announcement. Beyond their natural sensitivity to the equity rebound, FX investors may be positioning for a gradual return to conditions of lower volatility, which tend to favour carry and EM FX, alongside some stickiness in energy prices to which some high-beta currencies are positively exposed.

We suspect this preference for higher beta currencies over lower beta, more liquid alternatives such as EUR, GBP, and JPY can persist as long as markets are not given a reason to question the de- escalation narrative. Iran said yesterday that the ceasefire had been violated, helping the dollar recover a small portion of its losses. That serves as a reminder that the situation remains highly uncertain and that small bouts of re-escalation are still possible even if the conflict moves towards a broader resolution.

On the macro side, the Federal Reserve minutes yesterday caused a small hawkish reaction - with swap rates now embedding only 7bp of easing by year-end after touching 15bp earlier yesterday. The main highlight of the minutes, in our view, was, however, the reinforcement of two-sided risks stemming from the war, with faster cuts discussed as an option should job losses outpace inflation. We see room for dovish repricing in Fed expectations from here - a dollar negative.

This is not an environment for outright EUR strength, given investors’ preference for higher beta currencies. Still, European Central Bank pricing could give the euro more durable support than elsewhere. While falling energy prices have driven a dovish repricing in the EUR swap curve, markets continue to discount around 58bp of tightening by year-end.

We doubt that a modest further decline in energy prices alone would be enough to push ECB pricing below 50bp. Rate cycles at the ECB are typically framed around two 25bp moves or nothing at all, meaning a material dovish shift would likely require explicit guidance rather than just lower oil prices.

With no permanent ceasefire in place and uncertainty around oil flows persisting, the ECB is unlikely to rush towards a decisively dovish narrative. That could prompt the euro to outperform other currencies (like USD) where pricing appears to be more flexible on the dovish side.