FX Talking: Caught between war and Warsh

FX markets remain caught in a delicate balance between events in the Gulf region and the Federal Reserve's crucial meeting on September 16th. The narrow path that we favor involves lower energy prices and unchanged Fed policy, which could result in a gradual weakening of the dollar. This outcome hinges on two important US CPI prints before the FOMC meeting.

If those figures fall short of expectations, it could signal an impending Fed hike and a stronger dollar. When paired with a European Central Bank rate increase in September, we anticipate a modest rise in EUR/USD to 1.18 by year-end. An unchanged Fed stance would also present more opportunities for intervention to push USD/JPY lower.

The Bank of Japan may consider raising rates in September as an exchange for US involvement in intervention, but we suspect Washington might be aiming to curb the slide of North Asian currencies to prevent the renminbi from reclaiming recent gains. We believe USD/JPY has likely peaked, and USD/CNY could continue to decline further.

In the G10, a risk-on environment should continue to favor high-yielding currencies, particularly those with some commodity exposure. This could keep the Australian dollar and Norwegian krone in demand. The British pound, while offering a relative high yield, may face challenges as the Bank of England's dovish stance begins to loosen in the autumn.

Additionally, the UK Budget in October could introduce an event risk. Assuming our Fed outlook is accurate, the next few months could present a supportive environment for emerging currencies. Some of the highest yields are currently found in Latin America, and the Brazilian elections in October could pose a threat to the otherwise popular real.

In the EMEA region, Turkey is expected to maintain its foreign exchange regime, and the Hungarian forint should continue to attract inflows as the euro adoption narrative unfolds.