Oil Price Rebound Pressures Asian Currencies, MUFG Reports

In a recent research note, MUFG's currency analysts highlighted a direct link between the ongoing Middle East conflict and the performance of Asian currencies. The increase in geopolitical risk premia and a significant drop in tanker transits through the Strait of Hormuz—reportedly down to just four vessels on Sunday—are pushing Brent crude prices higher. This rise is particularly impacting net oil-importing countries like Thailand and India, which already face external vulnerabilities.

The Thai baht and Indian rupee both weakened by about 1% against the US dollar last week, a movement that occurred despite a slight softening in the broader dollar index following June's inflation data. This suggests that the decline in these currencies is more closely tied to oil prices rather than general dollar strength.

MUFG noted that Thailand's balance of payments is deteriorating, leading to increased downside risks for the baht. If oil prices continue to rise due to persistent disruptions in the Strait of Hormuz, both the baht and rupee could face further pressure.

The rebound in oil prices is occurring amid a broader inflationary context. Brent crude has seen gains as geopolitical tensions escalate, contributing to an inflationary impulse even as US data indicates only a partial easing of price pressures. US Treasury yields have decreased following softer CPI and PPI data from June, but they remain above 4%. The University of Michigan survey revealed that 1-year consumer inflation expectations moderated to 4.2% in July from 4.6% previously, while longer-term expectations held steady at 3.3%.

In light of these developments, the Federal Reserve's Vice Chair has suggested that the central bank may need to consider raising interest rates if inflation does not show signs of cooling. This commentary has helped maintain the strength of the dollar, as measured by the DXY index, despite some recent softening.

Additionally, the University of Michigan's consumer sentiment index rose to 54.4 in July from 49.5 in June, surpassing consensus expectations and indicating improving consumer confidence amid ongoing inflation concerns.

Overall, the rupee and baht were the weakest performers in the region last week, largely due to their heightened sensitivity to the current oil price rebound, according to MUFG's analysis.