ING FX Daily - FJElite

The dollar enters Fed week ahead of Wednesday's decision with better momentum. Last week, EUR/USD finally edged lower from its recent range as markets took the escalation in the Middle East more seriously. However, Brent has fallen back to $92/bbl, likely on the back of news that Iran and Oman are negotiating over the Strait of Hormuz and a second day of a pause in fighting with the US.

As discussed in last week's webinar, it would not take much to push oil back above $100 and even $120. Unless conflict continues to pause and negotiations gain traction, we still see room for the dollar to strengthen in the near term.

A lack of de-escalation over the next 48 hours should also keep pressure on the Federal Reserve to sound hawkish on Wednesday. In our preview, we explain why we expect rates to remain on hold, but also why oil has firmly reclaimed a central role in shaping monetary policy expectations. We also suspect that Chair Kevin Warsh's dislike of forward guidance raises markets' perceptions of meeting-day surprise risks. That could encourage precautionary USD buying ahead of the announcement. Markets currently price 8bp for this meeting and 41bp by year-end.

The key US data release this week is Thursday's second-quarter GDP report. Consensus expects annualised quarter-on-quarter growth of 2.1%, unchanged from IQ. June core PCE is forecast at a moderate 0.2% month-on-month, although it may already look stale by then.

EUR/USD has bounced back above 1.140 as oil prices dropped sharply today. Still, that move looks somewhat optimistic given the absence of a clear de-escalation path. Any renewed military strikes could quickly send Brent back to $100/bbl and EUR/USD below 1.1380. Potential precautionary USD buying ahead of the FOMC may also weigh on the pair into Wednesday.

Gas prices are another reason we remain cautious on EUR/USD unless tensions ease quickly. Even after today's decline, TTF is trading at €58/KWh, more than 30% above levels at the start of July and close to the March highs. So while Brent is nowhere near its peaks, gas is. Given its importance in eurozone energy imports, the euro's terms of trade - statistically the most important medium-term driver of EUR valuation - are also hovering near March lows and at levels comparable to 2023.