Energy Shock and Deteriorating Terms of Trade Boost the Dollar; FX Market Divergence Intensifies

Overview

This report analyzes the divergent trajectories of major global foreign exchange markets amid geopolitical conflict—particularly against the backdrop of the Iran war—and persistently high energy prices. Its core conclusion is that dramatic shifts in terms of trade are reshaping the FX landscape: the US is emerging as a relative winner thanks to AI-driven growth and energy-related advantages, thereby supporting dollar strength. Meanwhile, European, Asian, and emerging-market economies face distinct policy dilemmas and growth constraints, placing downward pressure on the pound, Asian currencies, and select emerging-market currencies. The report specifically revises forecasts for the Turkish lira and Norwegian krone, reflecting contrasting impacts of political risk and energy windfalls.

Core views

Regarding the US dollar, the report asserts that its foundation has become more robust. The earlier expectation of diminishing US exceptionalism has not fully materialized; instead, AI-sector dynamism and 'higher-for-longer' energy prices have made the US a relative winner. Recent weaker-than-expected April activity data from China and slowing May PMIs in Europe further confirm this growth divergence. As long as commodity flows remain constrained, broad-based and sustained dollar appreciation pressure persists. On the British pound, recent EUR/GBP movements are characterized as oscillations in the GBP risk premium. Although UK data have been weak, easing risk premiums and bond market stability have supported sterling. However, structural overvaluation, full pricing-in of Bank of England rate hikes, rising borrowing costs, and energy pressures continue to pose medium-term downside risks to the pound. The report identifies EUR/GBP as a clean instrument for capturing GBP risk premium fluctuations, while GBP/AUD and GBP/USD better reflect the medium-term downtrend. Emerging-market FX (EMFX) faces dual headwinds from rising US Treasury long-end yields and weakening risk sentiment. Analysis shows that if the 10-year US Treasury yield rises by more than 20–30 basis points per month—the 'speed limit'—EM currencies will struggle even if cyclical equities perform well. The South African rand, Colombian peso, Polish zloty, and Hungarian forint exhibit the highest sensitivity to US real yields. In contrast, the Mexican peso demonstrates greater resilience and serves as an attractive long position for EM carry trades, while the Chilean peso and Thai baht can function as funding currencies to enhance portfolio resistance to yield volatility. In Asia, rising inflation and currency weakness have forced Asian central banks to abandon their 'look-through-the-noise' stance and join the hiking cycle. The Philippines and Indonesia have already hiked rates, and Korea, India, and Canada (note: CBC typically refers to the Bank of Canada, but given the regional context—RBI/BoK—and the title ‘NJA FX’, this likely reflects either a contextual misnomer or a reference to another regional authority; we retain the original mention of BoK, RBI, and CBC as stated) are expected to follow. Despite tighter monetary policy, negative terms-of-trade shocks dominate, and the Philippine peso, Indian rupee, Indonesian rupiah, and Thai baht are expected to underperform. For the Australian dollar, soft domestic data has pushed back the Reserve Bank of Australia’s final hike expectation from June to August. The strong run in AUD/NZD has stalled, and reversal is possible should risk sentiment shift or terms-of-trade support weaken. Nevertheless, owing to its exposure to Chinese export growth and positive carry attributes, the Australian dollar remains relatively resilient versus the US dollar. The Norwegian krone is viewed as a high-quality energy hedge. Its performance closely tracks Brent oil long positions, and Norway’s unique fiscal framework enables it to benefit from prolonged high energy prices by improving future fiscal capacity. The report upgrades EUR/NOK and NOK/SEK forecasts, viewing them as attractive—but notes upside potential may be limited relative to other commodity exporters due to linkages with European cyclical conditions. The Turkish lira confronts mounting macroeconomic and political risks. Since the onset of conflict, the lira has followed a managed depreciation path, but recent political uncertainty—including the court’s disqualification of an opposition leader from elections—has intensified reserve pressures. Structural deterioration in the core trade balance also remains a concern. Given the accelerating pace of depreciation and passage of time, the report raises its USD/TRY forecasts to 48 at 3 months, 50 at 6 months, and 54 at 12 months.

Analysis framework

The report primarily employs a 'terms-of-trade' analytical framework to assess FX dynamics, emphasizing how energy prices and AI-sector disparities affect national relative growth and currency valuations. It substantiates dollar strength by comparing US activity indicators with those of the rest of the world. For the pound, it applies Goldman Sachs’ Behavioral Equilibrium Exchange Rate (GSBEER) model to decompose actual vs. model-implied real exchange rate deviations and isolate risk premium fluctuations. In the EM section, regression analysis quantifies currency sensitivities to US real yields, equity, and commodity prices, establishing the yield 'speed limit' as a stress threshold. For specific currencies such as the Norwegian krone and Turkish lira, the report conducts deep fundamental analysis incorporating fiscal mechanisms, reserve asset trends, and political developments.

Methodology notes

• Industry/sector analysis framework

  Determinative role of terms of trade (TOT) in FX valuation

  The report emphasizes that changes in a country’s ratio of export to import prices—the terms of trade—directly alter national income and growth prospects, thus driving exchange rate movements. Here, surging energy prices improve the TOT for energy-independent or exporting countries like the US, while worsening it for energy-importing regions such as Europe and Asia—constituting the core logic behind dollar strength.

• Valuation methodology

  GSBEER model (Goldman Sachs Behavioral Equilibrium Exchange Rate model)

  An econometric model used to assess whether a currency is over- or undervalued. The report applies this model to decompose the GBP’s real exchange rate, isolating the component driven by 'risk premium' to distinguish between fundamentals-driven and sentiment-driven movements—informing timing decisions for trading.

• Quantitative/factor/portfolio theoryBeta/alpha analysis

  Beta sensitivity analysis of currencies to US Treasury yields

  The report calculates each emerging-market currency’s beta sensitivity to changes in the US 10-year real yield. This helps investors identify which currencies (e.g., ZAR, COP) are most vulnerable to rapid US rate increases—and which (e.g., MXN) demonstrate resilience—thereby optimizing risk exposure within carry trade portfolios.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• US Dollar Index (DXY)

  Benefited

  Strengths

  US relative outperformance amid AI boom and high energy prices; improved terms of trade; weak economic data from Europe and China.

  Weaknesses

  Potential for short-term sell-off if risk sentiment improves sharply or tech-stock concerns re-emerge.

  Comparison

  Has stronger fundamental support relative to the euro and pound.

  Risks

  Sudden de-escalation of geopolitical conflict leading to sharp energy price collapse.

• Norwegian Krone (NOK)

  Benefited

  Strengths

  Excellent energy credentials, high correlation with oil prices; Norway’s unique fiscal framework converts energy profits into long-term fiscal capacity; valuation models indicate remaining appeal.

  Weaknesses

  Tied to European cyclical conditions, limiting outperformance versus other commodity currencies.

  Comparison

  Offers superior energy-hedging properties relative to other G10 currencies.

  Risks

  European recession dampening demand.

• Turkish Lira (TRY)

  Adversely affected

  Strengths

  Central bank reserve buffers currently sufficient to absorb temporary shocks.

  Weaknesses

  Rising political uncertainty; structural deterioration in core trade balance; reserve assets USD 38 billion below pre-war levels; accelerating depreciation pace.

  Comparison

  Faces unique political and macroeconomic dual risks among emerging-market currencies.

  Risks

  Accelerated local dollarization; gold reserve valuation volatility; large USD swings.

• British Pound (GBP)

  Adversely affected

  Strengths

  Recent decline in risk premium offers short-term respite.

  Weaknesses

  Structural overvaluation; full pricing-in of BoE hikes; rising borrowing costs and energy pressures heighten fiscal uncertainty.

  Comparison

  More sensitive than the Australian dollar or US dollar to the negative impact of deteriorating terms of trade.

  Risks

  Prolonged leadership challenges; erosion of commitment to fiscal policy rules.

Key data

• USD/TRY Forecast (3-month)48Raised from prior 46, reflecting accelerated depreciation and heightened political risk
• USD/TRY Forecast (6-month)50Raised from prior 48
• USD/TRY Forecast (12-month)54Raised from prior 52
• EUR/NOK Forecast (3/6/12-month)10.60 / 10.60 / 10.50Lower forecasts imply bullish outlook for the Norwegian krone
• NOK/SEK Forecast (3/6/12-month)1.04 / 1.02 / 1.00Bullish outlook for the Norwegian krone versus the Swedish krona
• US Treasury Yield 'Speed Limit'20–30 bp/monthExceeding this pace places broad pressure on emerging-market currencies
• Turkey’s Reserve Asset GapUSD 38 billionBelow pre-war levels, constraining central bank intervention capacity

Impact & implications

The report concludes that global FX markets are entering a new phase dominated by 'energy shocks' and 'growth divergence.' For investors, simple risk-on/risk-off dynamics are no longer sufficient drivers; structural shifts in terms of trade make the dollar more defensive and appreciating amid volatility. Shorting energy-sensitive Asian currencies and the pound—and going long the dollar and Norwegian krone—represent key strategic directions. Simultaneously, significant intra-EM divergence is expected, requiring selective positioning in currencies with low sensitivity to US yields and specific cyclical exposures (e.g., the Mexican peso).

Risks

• Sudden end or de-escalation of geopolitical conflict—especially the Iran war—causing rapid energy price declines, undermining the logic supporting the dollar and Norwegian krone.
• Renewed concerns about US tech stocks or a sharp improvement in risk sentiment triggering short-term dollar selling.
• Further escalation of Turkish political uncertainty, sparking widespread local dollarization and capital flight, exhausting central bank reserves.
• US Treasury yields rising far faster than anticipated, causing disorderly declines in emerging-market currencies.
• A deeper-than-expected European recession limiting the Norwegian krone’s upside via cyclical linkages.

What to watch

• Clarity on the normalization path for energy flows through the Strait of Hormuz.
• Whether the monthly change in the US 10-year Treasury yield breaches the 20–30 basis-point 'speed limit'.
• Changes in the Central Bank of Turkey’s reserve assets and the extent of local dollarization.
• Subsequent rate-hiking actions and magnitudes by Asian central banks (e.g., Korea, India).
• Developments around the UK’s June 18 by-election and related leadership challenges.
• Continuity of China’s export-led growth momentum and its supportive effect on the Australian dollar.