April was a month of transition and retracement as the March risk-off/war premium reversed alongside a sharp collapse in market-priced rate hikes. The USD, which had rallied sharply in March on the back of the Middle East war and a repricing of Federal Reserve expectations, gave back a significant portion of those gains as optimism about a negotiated settlement took hold. The Dollar Index fell for three consecutive weeks, its longest losing streak in a year, and briefly traded below 97.65, its lowest level since the conflict began, before recovering slightly ahead of month-end.
The relative performance chart tells the story clearly. The Australian dollar led the G10 pack, gaining over 4.3% month-to-date against the greenback, propelled by aggressive Reserve Bank of Australia (RBA) tightening and robust commodity prices. Sterling and the New Zealand dollar followed closely, both appreciating nearly 3%, as the market unwound safe-haven USD positions and re-engaged with higher-beta currencies. The euro and Swiss franc posted solid gains of around 2.4% and 2.2% respectively, while the Japanese yen lagged the recovery, gaining only 1.4% as the Bank of Japan (BOJ) signaled no immediate urgency to hike rates. The Canadian dollar also underperformed, held back by deteriorating labor market data and concerns over USMCA renegotiations, despite the pullback in the USD.
The primary driver throughout April was the shifting geopolitical narrative. Progress in US-Iran negotiations and a ceasefire between Israel and Lebanon fueled a powerful risk-on move. The S&P 500 and Nasdaq reached new record highs, while oil prices tumbled, June WTI fell 7.6% last week alone, briefly trading below $79 per barrel after peaking near $104 in early March. This reversal in sentiment triggered a dramatic unwind in rate expectations. At the height of the war panic in late March, the swaps market had priced in more than three Federal Reserve hikes and nearly three European Central Bank (ECB) hikes. By month-end, those expectations had collapsed to roughly a 65% chance of a single Fed cut this year, and two ECB hikes with the first not fully priced until July.
Middle East War and Oil
The war remained the dominant fundamental condition, but the market's base case shifted from escalation to resolution. The backwardation in oil prices, May WTI near $111 versus September below $78, reflected this tension. While shipping disruptions, insurance costs, and supply chain bottlenecks will linger, the immediate threat of a regional energy crisis receded, removing a key pillar of USD support.
Central Bank Divergence
The RBA emerged as the most hawkish G10 central bank, hiking twice already this year and signaling a third move in early May. Governor Bullock's rhetoric has been unambiguous: inflation remains too high, and the board is prepared to act pre-emptively. In contrast, the BOJ dashed market expectations by failing to prepare the ground for an April hike, causing the probability of a move to collapse from 75% to under 7%. The market now looks to June or July for the next Japanese tightening. The Bank of England (BOE) finds itself in a more delicate position. The UK economy showed surprising resilience, February GDP rose 0.5%, the strongest monthly print since June 2023, but inflationary pressures from higher energy costs and political uncertainty ahead of the May 7 local elections have kept rate expectations volatile. The swaps market now prices in two BOE hikes this year, down from a peak of three in late March.
Federal Reserve in Flux
Perhaps the most underappreciated story is the institutional uncertainty at the Federal Reserve. Chair Powell's term ends on May 15, and while Kevin Warsh's confirmation as successor has been cleared by the end of the Justice Department's probe, his confirmation hearing revealed a clear break from the Bernanke-Yellen-Powell era of continuity. Warsh has signaled potential changes to the inflation target framework and a rethinking of the Summary of Economic Projections. With no FOMC meeting in May, we expect Powell to remain in a caretaker capacity until Warsh takes the chair at the June meeting, but the transition adds an extra layer of uncertainty to USD positioning.
What to Watch in May
RBA Decision (May 5)
The market is pricing in roughly a 75% chance of a 25bp hike to 4.35%. Citi's Josh Williamson warns that the RBA's "headache is about to become a migraine," with headline inflation potentially reaching 5.5% by mid-year. We expect the hike to be delivered, but the accompanying Statement on Monetary Policy will be critical for gauging whether the board sees a terminal rate near 4.60%. A hawkish surprise could extend the Aussie's rally, though technical indicators suggest it is overbought above $0.7200.
UK Local Elections (May 7)
The ruling Labour Party is expected to suffer significant losses. Council seat losses approaching 1,500–2,000 could trigger a leadership challenge to Prime Minister Starmer, who is already under fire over the Peter Mandelson appointment in the wake of the Epstein revelations. Deutsche Bank warns that a sufficiently poor showing could keep risk premia elevated in UK gilts and sterling. With 10-year yields already above 5.00%, political instability could push them another 10–20bps higher. The pound's recovery to $1.35 may face a stern test if the results reignite fiscal concerns.
US Jobs and Fed Transition (May 8)
The April nonfarm payrolls report will be scrutinized for signs that the labor market is cooling sufficiently to justify the market's dovish Fed repricing. The Atlanta Fed's GDPNowcast for Q1 sits at 1.3%, and any significant jobs miss could cement expectations for a cut later this year. However, with Warsh's confirmation still pending and Powell's term ending mid-month, Fed communications will likely be cautious.
Oil and Geopolitical Risk
While the market is pricing in de-escalation, the situation remains fragile. The firing of US army generals and new attacks on Middle East infrastructure in early April served as a reminder that the conflict could reignite quickly. Any breakdown in negotiations would likely see oil prices spike and the USD reassert itself, particularly against the euro and yen.
USMCA and Trade Policy
The US review of the USMCA pact is ongoing, with discussions around boosting domestic content requirements in the auto sector. This poses a specific risk to the Mexican peso and Canadian dollar, both of which have benefited from the April USD weakness. Mexico has moved to ease tensions over electricity market access, but the renegotiation timeline remains a source of uncertainty.
Conclusion
May opens with a sense of transition rather than resolution. The aggressive tightening cycles priced in during the war's peak have been largely unwound, but inflationary pressures from higher energy costs are proving stickier than hoped. The RBA is likely to hike again, the BOJ remains on hold with the next move likely higher, and the ECB and BOE both have rate hikes priced for 2026. Notably, the Federal Reserve stands alone among major central banks in having no rate hike discounted for this year, in fact, the market leans toward eventual cuts, which leaves the Fed looking dovish by comparison even as it remains in leadership limbo. The Bank of Canada, meanwhile, sits alongside the Fed in the on-hold camp, with Governor Macklem taking a cautious, data-dependent stance after the March cut to 2.75%. For FX dealers, the key trade is navigating the divergence between central banks that are still hiking or hawkish (Australia, UK, eurozone, Japan) and those that are on hold with a dovish tilt (US, Canada) or actively cutting (Mexico). The USD's correction may have further to run in the near term, but with geopolitical risk still simmering and US rate expectations already heavily skewed toward cuts, the downside from current levels may be limited. Watch the RBA, the UK ballot boxes, and any headlines from the Middle East, they will set the tone for the month ahead.