Energy Price Surge Fuels Market Volatility Ahead of Fed Decision
High energy prices have led to increased volatility in the bond, equity, and FX markets, causing pressure on popular summer carry trades. The energy-exporting currencies backed by central banks ready to tighten are gaining attention.
The market expects the Federal Reserve to respond to rising energy prices with interest rate hikes. President of the ECB, Christine Lagarde, stated that the central bank would hike rates in September, and markets now price a further 75bp of tightening for both the ECB and the Bank of England.
Two-year real USD swap rates have risen 30bp since the June FOMC meeting as investors buy into the Fed's message to restore credibility when fighting inflation. The dollar is expected to outperform, with the DXY near June's 101.80 high and a potential upside breakout.
The euro has been impacted by high energy prices weighing on European growth prospects and a larger adjustment in real rates in the US than in the eurozone. Two-year real EUR/USD swap differentials have widened to levels last seen in late 2024 when EUR/USD was trading under 1.10.