Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist 

Stocks flew, oil sank, and bond yields tumbled on Monday in a highly volatile start to the week, as traders digested Iran's response to the US strikes on its nuclear sites and a string of dovish remarks from Federal Reserve officials.

In my column today I ask a simple question, one which has several plausible answers: Who's selling the dollar? More on that below, but first, a roundup of the main market moves.

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Early on Monday, oil prices were up 6% at a five-month peak on fears that Iran could seriously disrupt global crude supplies by closing the Strait of Hormuz. Several Middle East countries closed their airspace, and the dollar was rallying strongly.

The reversal by the close of U.S. trading was remarkable - oil fell 7% and broke below its 200-day moving average, stocks closed firmly in the green and the dollar ended lower. What was the catalyst? 

There were probably two. 

The first was Tehran's response to Washington's attacks on its nuclear facilities on Saturday. Iran attacked a U.S. military base in Qatar, but took no action to disrupt oil and gas tanker traffic through the Strait of Hormuz. 

Oil's stunning 13 percentage point swing on Monday is an indication of the premium that had been built into the price on fears that global supply could be disrupted. If supply is maintained, the collective sigh of relief will extend to businesses, households, and policymakers around the world.

And this is where the second catalyst comes in - inflation expectations and monetary policy. 

Two Federal Reserve officials struck a dovish tone in their public remarks on Monday, Chicago Fed President Austan Goolsbee and Vice Chair for Supervision Michelle Bowman. They come on the heels of Governor Christopher Waller on Friday. 

Goolsbee and Waller are perhaps the two most dovish of all the Fed's 19 policymakers, while Bowman has for years been at the opposite end of the 'hawk-dove' spectrum. But on Monday she said she would consider voting for a rate cut as early as next month as long as inflation pressures remained contained.

If the worst of the oil price spike has now been and gone - that's a big 'if', given how fragile and fluid the situation in the Middle East is - then disinflationary forces and soft growth and labor market dynamics could take on more significance for policymakers and investors alike.

That's all very hypothetical at this stage, but Monday's sharp moves are an indication of where positioning and sentiment have been building in recent weeks. 

Next up is Fed Chair Jerome Powell, who delivers his semi-annual testimony to Congress on Tuesday and Wednesday. Will he nod to the Waller-Goolsbee-Bowman view, repeat the hawkish signals from last week's revised 'dot plot', or hold the narrowing middle line between the two? 

With the dollar poised for its worst first-half performance since 1986, the selling may seem to be coming from everyone, everywhere, across every asset class.

To some extent, that's true. Investors globally appear to be gradually reducing their exposure to dollar-denominated assets, driving the greenback down to its lowest level against a basket of major currencies in three and a half years. But some pressure points are greater than others. 

Unsurprisingly, non-U.S. investors are responsible for the bulk of the selling, with equity-related selling pressure concentrated among European investors and fixed income-based selling mostly coming from Asia. 

According to Bank of America's FX strategy team, European "real money" investors - institutions like pension funds and insurance companies - are the main drivers of the dollar's selloff in the second quarter, slashing their dollar positioning to the lowest since 2022 in a matter of weeks.

But the story might not be so straightforward. While European investors increasing their dollar hedge ratios have garnered much attention recently, research shows that most of the dollar's average daily declines in the last few months have come in Asian trading hours, suggesting Asian holders of U.S. bonds may also be increasing their dollar hedges.

So which is the bigger drag on the dollar: equity-led geographic diversification or fixed income selling? And where is the selling mostly coming from: Europe or Asia?