Synopsis:

ING assesses potential impacts on the FX and oil markets in response to escalating tensions between Iran and Israel. Key currencies and their movements are highlighted, with a particular focus on how geopolitical developments could influence market dynamics.

Key Points:

• Vulnerability of Certain Currencies: ING predicts that in the event of further escalation, currencies such as the New Zealand Dollar (NZD), Australian Dollar (AUD), Swedish Krona (SEK), and Norwegian Krone (NOK) might lead losses in the G10 group. Despite their correlations with rising commodity prices, these currencies are likely to be adversely affected due to prevailing risk sentiment.

• Relative Strength of the Canadian Dollar (CAD): The CAD is expected to perform relatively better among high-beta currencies, potentially benefiting from an increase in oil prices due to Canada's status as a major oil exporter, coupled with its geographical distance from the Middle East.

• Safe-Haven Currencies: The Japanese Yen (JPY) and Swiss Franc (CHF) are likely to gain from a flight to safety driven by lower interest rates and heightened risk aversion. The JPY could also see support from potential shifts in the Bank of Japan's policy if escalating energy prices stoke inflation concerns.

• Dollar's Positioning: While JPY and CHF could initially outperform the USD in a risk-off environment triggered by geopolitical tensions, the USD might retain its strength or recover losses more robustly. This resilience could be due to increasing bullish sentiment on the dollar, driven by recent strong US data and a divergence in monetary policy compared to other central banks.

• Impact on Oil Prices: A significant escalation could push oil prices back above $100 per barrel, influencing the Federal Reserve's monetary policy outlook by diminishing the likelihood of near-term easing.

• Emerging Markets and Carry Trades: Emerging Market (EM) currencies could face significant pressures if geopolitical risks intensify, potentially reversing recent strengths that were bolstered by popular carry trades. These currencies are vulnerable as the Fed continues on a path divergent from other more dovish central banks.

Conclusion:

As tensions between Iran and Israel threaten to escalate, ING highlights potential shifts in currency and oil markets, with specific impacts expected across various G10 and EM currencies.