Oil: Escalation risks and Dollar support – OCBC

OCBC’s Sim Moh Siong and Christopher Wong highlight rising geopolitical risks around Middle East supply routes, warning that a deeper conflict could push Oil back above USD100/bbl and revive volatility. They note markets are still priced for contained risks, but higher energy prices would bolster the USD as a net energy exporter and keep the Fed focused on inflation.

Middle East tensions threaten Oil outlook

"With a quiet data calendar and the Fed in its pre-FOMC blackout period, the USD traded largely sideways. Whether that calm persists remains uncertain as oil prices resume their climb. For now, crude has surrendered part of its gains on hopes that a diplomatic resolution remains possible."

"Our base case has been for a managed escalation in the Middle East, allowing low market volatility to persist, supporting FX carry trades and limiting further USD gains ahead of next week’s FOMC meeting. However, the risk of a broader conflict has risen following the deaths of three US soldiers in Iran-linked attacks."

"Shipping through the Strait of Hormuz has already slowed significantly. Oil prices rose further after reports that Yemen's Iran-backed Houthi group plans to restrict Saudi-linked maritime traffic in the Red Sea. Such a move would threaten one of the few alternative routes capable of offsetting disruptions in Hormuz, potentially tightening Middle East oil supplies."

"A larger escalation could revive fears of a prolonged supply shock and drive oil prices back above USD100/bbl. For perspective, Brent crude reached USD126/bbl in late April, around 40% above current levels."

"Such an outcome would likely trigger higher market volatility, erode the appeal of FX carry trades, and support a renewed USD rally."