Given the wide gulf between the positions of the United States and Iran, a renewed escalation of hostilities appeared increasingly likely. The downing of a US helicopter became the catalyst for a new round of tensions and retaliatory actions. However, the EUR/USD pair showed only a muted reaction. Why did the pair remain relatively resilient? Let’s examine the key drivers and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- The EUR/USD fell due to the escalation of the conflict.
- Oil and the US dollar are poised to rise.
- Inflation data will give investors a clear signal.
- Short positions opened at 1.1575 on the EUR/USD can be increased.
Weekly Fundamental Forecast for Dollar
The US had only two ways out of the impasse in the Middle East conflict: strike a lousy deal or resume airstrikes on Iran. As much as Donald Trump might have wanted to take the second path, the choice was apparent. The downed American helicopter served as the trigger for escalation. However, the EUR/USD pair displayed only a modest decline.
Everything is back to square one. After a prolonged truce, the resumption of hostilities may be viewed by financial markets as a déjà vu of late February. Investors prefer to trade based on familiar patterns. If the start of armed conflict in the Middle East led to a surge in oil prices and the US dollar, it is reasonable to assume that history could repeat itself.
Unfortunately, the smaller decline in EUR/USD quotes is a result of Donald Trump’s shifting stance. While at the start of the standoff with Iran the US president was confident of a quick and unconditional victory, he is now searching for a way out of the stalemate. The initial reaction to the US helicopter shot down by Iran was muted. As if to say, it was not a serious problem, and the pilots were unharmed.
Global Oil Inventories
Source: Wall Street Journal.
The fundamental implications of the escalating conflict in the Middle East are far more significant than Donald Trump’s mood swings. According to S&P Global Energy, global oil reserves will only return to pre-war levels by the end of the year under one condition: if the oil market sees a surplus of 1 million barrels per day. However, such a scenario is highly unlikely. Brent will inevitably rise, and with it, the US dollar will also surge.
Indeed, the higher oil prices climb, the greater the likelihood that US inflation will become firmly entrenched at elevated levels for the long term. This increases the chances of the Fed tightening monetary policy and will exert significant downward pressure on the EUR/USD pair.
US Treasury Yield and Fed Funds Rate
Source: Bloomberg.
The rise in US Treasury yields signals that the Fed needs to raise rates immediately. In essence, the US debt market is stepping in for the central bank by tightening financial conditions.
The key question is how quickly these second-order effects will feed into core inflation. Given the tight labor market and ongoing labor shortages, wage growth is likely to remain elevated. As a result, investors will be closely watching the release of the US May inflation data. It is expected to accelerate from 3.8% to 4.2%, while core inflation is projected to edge up from 2.8% to 2.9%.
Weekly Trading Plan for EUR/USD
If the actual figure comes in above expectations, the EUR/USD pair will likely plunge, allowing investors to increase short positions in the euro against the US dollar established at 1.1575. That said, the escalation of the conflict in the Middle East has not killed hope for peace. Donald Trump’s optimistic rhetoric could play a nasty trick on the greenback.
This forecast is based on the analysis of fundamental factors, including official statements from financial institutions and regulators, various geopolitical and economic developments, and statistical data. Historical market data are also considered.
Price chart of EURUSD in real time mode
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