USD firmer following US attack on Iran - Scotiabank

US Dollar (USD) bearishness subsided a little last week, helped by the mildly hawkish outcome of the FOMC, and has receded further this morning as markets react to the US attack on Iran's nuclear facilities and concerns over potential Iranian responses, Scotiabank's Chief FX Strategists Shaun Osborne and Eric Theoret note.

Asset markets remain subdued

"The USD is broadly higher on the session so far, with only the CHF able to resist the USD's advance. The MXN and CAD are outperforming marginally among the major currencies while the AUD, NZD and JPY are underperforming. Elsewhere, however, the market reaction is rather subdued. Stocks are narrowly mixed (down a little in Europe, up a little in US equity futures terms), major bond markets are a little softer overall and crude prices are somewhat firmer but choppy. USD gains suggest some risk aversion among investors but the broader market response is rather subdued."

"Iran/Israel continue to launch attacks at each other but options for Iran to respond to the US attack are perhaps limited. The parliament voted to close the Straits of Hormuz but the leadership has not endorsed action and tanker traffic appears unaffected at this point. A broader escalation of the confrontation now seems a bigger risk, however. Fed Governor Waller's comment that the Fed might be in position to cut rates at the end July meeting is likely to remain a minority view among policymakers, given that last week's dots inferred a more cautious outlook among more policymakers than March."

"A jump in oil prices will only bolster Fed caution. Swaps reflect just 3bps of easing risk for July now, down from 6-7bps at the end of last week. Powell is likely to strike a guarded tone in his congressional testimony this week. The USD sell off might be due a pause but a sustained recovery is unlikely amid other, serious fundamental challenges--slower growth risks, flight from USD assets, twin deficit worries, valuation. Although seasonal trends have been weak for the USD so far this year, seasonality typically turns USD-negative as we move into July/August."