Forex Today: Mood sours as Mideast conflict widens, focus shifts to Fed

Here is what you need to know on Wednesday, July 29:

Markets turn risk-averse midweek as the crisis in the Middle East widens. Later in the American session, the Federal Reserve (Fed) will announce its interest rate decision and publish the policy statement following the two-day meeting.

Saudi forces have joined the conflict by launching attacks on Iran-aligned groups in Iraq alongside the United States (US), as retaliation to the Islamic Revolutionary Guard Corps' (IRGC) drone attacks on Saudi oil facilities. Meanwhile, Iran claimed an attack on a US military base located in Jordan. Following a two-day decline, crude Oil prices push higher on Wednesday, with the barrel of West Texas Intermediate (WTI) trading above $81, rising nearly 4% on the day.

Oil rebounds as Middle East attacks end recent truce-driven sell-off

According to Deutsche Bank, the recent calm in oil markets has been abruptly interrupted, with sentiment having "soured overnight as the US said that it intercepted an Iranian attack against its bases in the Middle East," effectively ending the brief pause in hostilities. The bank notes that this lull had seen Brent crude "decline from above $100/bbl last Thursday to only $84.09/bbl at yesterday’s close," a move they describe as its "sharpest three-day decline (-16.5%) since April 2020."

ING analysts add that "after a heavy sell-off in the oil market over the last three days, prices popped higher in early morning trading, with Brent up more than 4% at the time of writing." They attribute this "renewed strength" to the latest escalation, highlighting that it "comes after the US said it intercepted a surprise attack on US troops." ING further points out that "Saudi Arabia intercepted drones from Iranian-backed groups in Iraq, which were targeting Saudi energy infrastructure," underscoring how the emerging security risks are feeding directly back into crude prices.

The US Dollar (USD) Index struggles to benefit from risk-aversion and holds steady at around 101.30 in the European session, as investors refrain from taking large positions ahead of the Fed policy announcements. While the Fed is anticipated to keep the interest rate unchanged, the CME FedWatch Tool shows that there is about a 30% chance of a 25 basis points (bps) hike.

After posting small gains on Tuesday, EUR/USD trades in a narrow channel at around 1.1400 early Wednesday.

GBP/USD corrects higher and trades a few pips above 1.3300 in the early European session.

Fed risk keeps front-end Euro and Pound markets on edge

Analysts at ING argue that the FOMC is likely to stay on hold, stating, “We don't think the FOMC will hike rates, but markets see a 30% probability that it does.” They note that a more hawkish tone alone could see “the front end of the EUR and GBP markets… move even higher on a hawkish tilt,” while “longer-dated global rates, however, could find resistance to follow through, especially if the positive market sentiment gets challenged by a tightening of financial conditions.”

ING also flags the risk of a more adverse outcome if the Fed does deliver a surprise hike, warning that “market sentiment takes a hit if the Fed hikes as risk assets suffer from tighter financial conditions,” with “increasing jitters in equities on the back of AI uncertainties” already evident. In such a scenario, they suggest “the curve reaction should be of interest,” as investors reassess the balance between front-end repricing and the ability of long-end yields to keep pace.

The data from Australia showed earlier in the day that annual inflation, as measured by the change in the Consumer Price Index (CPI), declined to 3.8% in June from 4% in July. This print came in below the market expectation of 4%. AUD/USD remains under bearish pressure on Wednesday and trades at a fresh two-week low near 0.6950.

Gold holds steady above $4,000 after posting losses for two consecutive days.

USD/JPY edges lower and trades at around 163.50 in the European morning on Wednesday.