Escalation in the Middle East has led markets pricing in a greater risk of a fully-fledged conflict in the region, which could potentially involve the US. Iran fired missiles at Israel yesterday evening, and while most were intercepted (the US called the attack ‘ineffective’), some targets have been reportedly hit. Israel has pledged to retaliate against Iran as it continues its ground offensive in parts of Lebanon, ING’s FX strategist Francesco Pesole notes.

Geopolitical events set to remain the main driver

“Oil rallied on the news that Iran was preparing a missile attack yesterday, and stalled overnight around $74-75 bbl while awaiting the magnitude of Israel’s retaliation. The situation remains highly volatile, but if Israel’s response is not too aggressive, markets may take the view that both countries are for the second time this year preferring to de-escalate after a brief hostile exchange. The USD strengthened on the back of rising geopolitical tensions, with the Canadian dollar also rallying.”

“Domestic US developments have been overshadowed by geopolitics. The vice-presidential candidate debate for the US election didn’t attract much attention. Meanwhile, data is broadly endorsing Fed Chair Jerome Powell’s recent pushback against a 50bp cut. While the ISM manufacturing was a bit softer than expected and prices paid dropped below 50.0, the Fed is laser-focused on the jobs market.”

“Friday’s payrolls will be the usual binary event for FX, although Powell’s hawkish comments and the market's dovish pricing (still 70bp of cuts priced in by year-end) mean the bar for a USD-negative jobs report is higher. Today, we’ll see the ADP jobs figures, which can move the market but rarely have any predictive power for payrolls. Geopolitical events should remain the main driver.”