EUR/USD slipped into negative territory around 1.1635 in early Asian trading on Tuesday as the euro eased against the dollar, with demand for the US currency supported by uncertainty over a prospective US-Iran peace agreement. Later in the session, markets are due to hear from ECB policymaker Olaf Sleijpen and Minneapolis Fed President Neel Kashkari, events that could add to short-term volatility.
Geopolitical developments remained in focus after Fox News reported that US forces carried out “self-defense strikes” in southern Iran on Monday. A US Central Command spokesperson said the strikes targeted missile launch sites as well as Iranian vessels and boats that were attempting to deploy mines, while the US military said it would protect its forces while exercising restraint during the ceasefire. Separately, Bloomberg cited President Donald Trump as saying talks to end the conflict and reopen the Strait of Hormuz were “proceeding nicely”. On monetary policy, markets are pricing in nearly an 85% probability of a 25-basis-point ECB rate rise at the June meeting, according to the ECB Watch Tool.
Safe-Haven Flows and Rising Volatility
Given the uncertainty around the US-Iran peace deal, we see a classic safe-haven flow into the US Dollar, pushing EUR/USD lower. The market is nervous, and this is reflected in rising volatility. We’ve seen one-month implied volatility for EUR/USD options jump from around 6% to over 8.5% in the last few days, signaling that traders are pricing in larger price swings.
This geopolitical tension is directly impacting oil markets, with Brent crude futures climbing over 5% this past week to trade above $95 a barrel. Historically, conflicts in the Strait of Hormuz lead to sustained high energy prices, which tend to weigh more heavily on the energy-importing Eurozone than on the United States. This dynamic could cap any significant rally in the Euro, even with a hawkish European Central Bank.
Central Bank Divergence and Trading Strategies
We are watching the clear divergence between central bank expectations. While markets are pricing in an 85% chance of a 25-basis-point ECB rate hike in June, the CME FedWatch Tool suggests only a 20% probability of a similar move by the Federal Reserve. Normally this would be bullish for the Euro, but the geopolitical risk is currently the market’s primary focus.
For the coming weeks, we believe derivative strategies that profit from this heightened uncertainty are prudent. Buying straddles or strangles on EUR/USD could be an effective way to trade the expected price movement without betting on a specific direction. Alternatively, for those anticipating further escalation, buying put options with a strike price around the 1.1500 psychological level offers a defined-risk way to position for more downside.
We will be paying close attention to any statements from ECB and Fed officials later today for clues on their reaction to these inflationary pressures. Any signs that the US-Iran situation is worsening will likely accelerate the flight to safety, strengthening the dollar further. Conversely, credible news of a breakthrough in peace negotiations could cause a sharp reversal and a squeeze on short Euro positions.
