HSBC's report on G8 currencies argues that Middle East geopolitics and Oil remain the dominant drivers for the Dollar and major FX. The bank highlights a recently strengthened USD–Oil correlation driven by supply shock and safe-haven flows. HSBC adds that if this link weakens, pre-conflict FX fundamentals could regain influence over G8 currency performance.

Geopolitics, Oil and shifting USD drivers

"Middle East geopolitics remain the primary driver of FX markets, but the headlines are difficult to interpret as tensions can escalate and ease quickly. We believe market direction may hinge on a few practical indicators, notably the extent ofshipping disruption through the Strait of Hormuz and the resulting path for oilprices. As geopolitical risk rises and falls, oil can move sharply, shifting market sentiment between “risk-off” and “risk-on”."

"Lower oil should support net importers and may improve risk appetite, with "risk-on" currencies likely outperforming "safe-haven" currencies; JPY may lag, though intervention risk rises around USD/JPY 158-162."

"Oil stabilising at this [$100] level may ease temporary pressure on net importers; global recession risk remains limited, but fiscal concerns could increase; FX likely range-bound with a mild USD tilt."

"A prolonged disruption to oil/gas flows via the Strait of Hormuz is likely to weaken market sentiment, lift safe-haven" demand, and hurt net energy importers via terms-of-trade effects."

"Nonetheless, if the positive oil and USD relationship began to show signs of weakening, then it could be an early indication (like ships cross the Strait of Hormuz) of pre-conflict FX behaviours returning. For example, FX fundamentals may regain influence relative to simple energy-price tracking when assessing relative currency preferences."

"Additionally, as the Federal Reserve (Fed) is neither in a rate-hiking cycle nor has turned outright hawkish, there are underlying factors that maycontinue to limit broad-based USD strength."

"Since the conflict intensified, the USD and oil prices have moved more closely together, unlike in prior months. This appears to reflect both an energy supply shockand increased “safe haven” demand for the USD."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)