- An escalation of the conflict in the Middle East will cause the euro to fall.
- A US-Iran deal could set off a rollercoaster ride for EURUSD.
The US dollar has stagnated amid the increasingly complex situation in the Middle East. US President Donald Trump has stated that negotiations with Iran are going well and that the result will be a major deal or no deal. Both sides appear keen to avoid a return to open conflict. However, the attack by US ships on minelayer vessels in the Strait of Hormuz has led to mutual missile attacks between the opposing sides.
Without a significant de-escalation, the euro risks continuing to fall. According to François Villeroy de Galhau, the ECB has not yet seen signs of second-order effects on inflation. This means that the deposit rate will increase less than the markets expect.
Meanwhile, signals from the Federal Reserve are getting hawkish, reinforcing the view that the federal funds rate will rise in 2026. Christopher Waller said that given the stabilization of the labor market and persistently high inflation, it would be crazy to talk about cutting rates. It will not be easy for Kevin Warsh to convince the Committee of the need for monetary expansion if he intends to do so.
An agreement between the United States and Iran could turn everything upside down. A drop in oil prices following the reopening of the Strait of Hormuz would reinforce the view that the acceleration in inflation is temporary. The chances of the Federal Reserve tightening monetary policy under these conditions will quickly fall from the current 55%, putting pressure on the dollar. The pace of rate growth will depend on how quickly markets move from the view that the Fed will keep rates steady to the view that it will cut them.
We should not rule out the possibility that the US-Iran deal could fail again due to differences in the parties' positions. Any further escalation of the conflict would likely restore demand for the dollar as a safe haven asset.
For now, the basic scenario is one in which the United States and Iran first reach an agreement to open the Strait of Hormuz before moving on to broader discussions around the nuclear program. A stalemate in negotiations risks leading to a new blockage of the world's main oil artery.
The risks are high, so tanker owners will be extremely cautious when moving their cargoes. Oil prices are unlikely to fall sharply, and inflation remaining high will force the Federal Reserve to keep rate hikes in its sights. The result will be a roller coaster ride for EURUSD.
The FxPro Analyst Team
