EUR/USD traded firmer on Tuesday as tentative steps towards de-escalation in the Middle East reduced safe-haven support for the US Dollar, while softer oil prices underpinned the euro given the Eurozone’s dependence on imported energy. The pair was around 1.1553 at the time of writing, rebounding after touching a two-month low of 1.1499 on Monday. US President Donald Trump said the United States and Iran were nearing an agreement and that Iran and Israel had agreed to halt hostilities, adding the Strait of Hormuz would reopen once a deal is finalised.
Tensions in the Gulf remained elevated, with Israel continuing operations in southern Lebanon and Iran warning fighting could resume if attacks persist, helping keep US Dollar pullbacks limited. The US Dollar Index (DXY) was near 99.89, down 0.12% on the day, while the currency also found support from hawkish Federal Reserve expectations: markets see a possible move as soon as September and place the probability of a 25-basis-point hike at about 35%, according to the CME FedWatch Tool. Focus shifts to Wednesday’s US CPI, forecast at 4.2% year-on-year for May versus 3.8% in April, ahead of next week’s Fed meeting where rates are expected to be left unchanged despite inflation sitting away from the 2% target. In Europe, markets are fully pricing an ECB hike on Thursday, with attention on guidance given stagflation risks.
Middle East De-Escalation Eases Dollar Demand
We are seeing the EUR/USD pair gain strength as geopolitical tensions in the Middle East show signs of easing, which is reducing the market’s demand for the safe-haven US Dollar. Recent diplomatic talks have lessened the immediate risk of conflict near the Strait of Hormuz, a key shipping lane for global energy. This has also helped push WTI crude oil prices down to around $78 a barrel, a welcome development for the energy-importing Eurozone.
Currently, the currency pair is trading around 1.0950, recovering from a low of 1.0880 reached last week during the height of the tensions. The US Dollar Index (DXY) reflects this movement, trading lower on the day near 103.55. These moves suggest that traders are shifting away from defensive positions for now.
Central Bank Caution Limits Currency Moves
However, we believe the dollar’s downside will be limited by the Federal Reserve’s cautious monetary policy stance. After making initial rate cuts earlier this year, the Fed appears to be in a holding pattern to assess their impact on the economy. Current market pricing from the CME FedWatch Tool shows only a 20% probability of another rate cut at the July meeting, indicating traders expect the Fed to wait.
The upcoming US Consumer Price Index (CPI) report this week will be a critical data point for derivative traders to watch. We are forecasting a year-over-year inflation rate of around 2.9%, which remains stubbornly above the Fed’s 2% target and could reinforce the case for delaying further cuts. Historically, periods of sticky inflation above 2.5% have often caused the Fed to pause easing cycles, creating support for the dollar.
Across the Atlantic, the European Central Bank (ECB) is facing its own challenges, which could cap the Euro’s gains. While the ECB has also begun an easing cycle, recent Eurozone inflation data showed core inflation holding firm at 3.1%, driven by the services sector. This stagflationary pressure may force the ECB to be more hesitant with future rate cuts compared to the Fed.
