Synopsis:

MUFG warns that the Federal Reserve is unlikely to act quickly to stem market turmoil sparked by US tariff policy and bond market volatility. With inflation still elevated, the Fed has little room to intervene decisively. In the event of a broader crisis of confidence, EUR/USD could climb to 1.20 as traditional FX drivers break down.

Key Points:

• Fed Likely to Stay Passive:

  • The current market turmoil is seen as “self-inflicted” from US fiscal and trade policies.

  • The Fed has already slowed QT and is unlikely to resume QE given inflation concerns.

  • FX intervention is considered highly improbable, with limited reserves and misaligned policy.

• Crisis of Confidence Scenario:

  • If markets enter a true confidence crisis, normal FX pricing mechanics could break down.

  • Current short-term rate differentials no longer explain the dollar’s weakness.

  • In such environments, price levels that once seemed out of reach—like EUR/USD at 1.20—can quickly become probable.

• Market Implications:

  • A steepening US yield curve, dollar selling, and the lack of credible Fed response could trigger a faster repricing of FX risk.

  • A June rate cut, previously expected, may now be challenged by markets.

Conclusion:

MUFG sees growing risks that FX markets could move into crisis dynamics, where fundamentals like yield spreads lose their predictive power. In that environment, EUR/USD at 1.20 is no longer a stretch. Investors should not count on the Fed to arrest market disorder without a broader US policy reversal.