Crude oil is driving the forex market

Crude oil is driving the forex market

• The longer Brent remains expensive, the tougher the Fed will be.
• The ECB will be cautious to avoid hurting the economy by raising rates.

The US dollar has taken another step forward, driven by the resumption of growth in Treasury yields and ongoing geopolitical tensions in the Middle East. In the bond market, competition with major corporations for investor capital continues. Meanwhile, the prolonged period of high oil prices is amplifying second-order effects, feeding into core inflation. This will force the Fed to raise rates more aggressively than is currently expected. The FOMC’s hawkish stance is underscored by recent comments from Lisa Cook, who confirmed that the factors mentioned above will drive up inflation in the coming months.

The oil market is sending a clear signal regarding expectations for the situation in the Middle East. November Brent futures are trading at $107, compared with $100 for the October expiry. The spread has risen sharply from $1–2 to $7. At first glance, this contradicts reports of an increase in traffic through the Strait of Hormuz to 13 million barrels per day, compared with 19 million barrels per day before the US-Iran conflict, and the resumption of operations on the East-West pipeline, which is currently operating at half its capacity of 7 million barrels per day but is set to recover in the coming weeks.

At the same time, the US blockade is hindering the sale of Iranian oil. This carries the risk of an escalation of the conflict by Iran, which has been backed into a corner. The likelihood of such a scenario is growing, which is widening the backwardation. Moreover, in recent weeks, it has been difficult to see any signs of a rapprochement between the parties. It appears that the parties have even moved somewhat further away from the idea of seeking a compromise.

The longer Brent remains expensive, the higher the risks of core inflation accelerating due to second-order effects. Investors are gradually adjusting their expectations regarding the key interest rate. Over the past week, the expected weighted average rate for 15 September 2027 has risen by 21 basis points to 4.88%. In other words, the central forecast now points to a further 4–5 rate rises over the next 12 months, compared with 3–4 a few weeks ago. The probability of a rate rise in October stands at 73%.

At the ECB, by contrast, the probability of a tightening of monetary policy at the next meeting fell from 39% to 31% following Christine Lagarde’s speech. She stated that the European Central Bank needs to strike a balance between the risks of accelerating inflation and the risk of a significant slowdown in the eurozone economy due to tight monetary policy. She does not yet see widespread price pressures arising from high energy costs.

The FxPro Analyst Team