EUR/USD was steady around 1.1610 in early Asian trading on Wednesday as markets waited for the Federal Reserve decision later in the day, alongside the release of US May Retail Sales. The Fed is expected to leave its benchmark rate unchanged at 3.50% to 3.75% at its June meeting, with attention turning to the press conference for guidance on the path of policy. The CME FedWatch tool shows markets pricing a 42.6% probability of a 25 bps rise by year-end, and any hawkish shift could support the US dollar and weigh on the pair.
Geopolitical developments also remained in focus, with talk of a deal to reopen the Strait of Hormuz seen as supportive for risk assets, including the euro. In Washington, JD Vance said Donald Trump may release a preliminary deal to end the war with Iran before Friday. Separately, the backdrop includes the Fed’s 2% inflation target and its dual mandate for price stability and full employment, while tools such as QE and QT shape liquidity conditions and can influence the US dollar.
Fed Policy, Guidance, and Market Volatility
With the Federal Reserve holding its benchmark rate steady at 3.50%-3.75% today, the focus has shifted entirely to future guidance. Chairman Warsh’s commentary was unexpectedly hawkish, stressing that the fight against inflation is not over despite political pressure. We believe this sets up a volatile environment as the market digests this divergence from Washington’s demands.
This uncertainty from the Fed creates a prime opportunity for volatility-based derivative strategies. Recent US data showed core inflation holding stubbornly at 3.4%, giving credence to the Fed’s tough stance. With 3-month implied volatility for the EUR/USD pair hovering near a relatively low 6.1%, we see value in buying straddles or strangles to profit from a significant price move in either direction.
The market is now pricing in over a 65% chance of a 25 basis point hike by September, a sharp increase from the 42.6% chance priced in last week. This hawkish repricing should put a floor under the US dollar, making it risky to bet against it without a clear catalyst. We will use any strength in the EUR/USD toward the 1.1650 level to initiate positions that benefit from a stronger dollar.
Geopolitical Wildcards and Data-Driven Strategies
A major wildcard remains the potential deal to reopen the Strait of Hormuz. Such a “risk-on” event would likely weaken the dollar and could send oil prices, with Brent crude currently trading over $81 a barrel, sharply lower. This would complicate the Fed’s inflation picture and could cause a rally in the Euro.
Given the binary nature of this geopolitical event, buying out-of-the-money EUR/USD call options offers a low-cost way to position for a surprise peace deal. A confirmed agreement could see the pair quickly break above resistance at the 1.1700 level. This strategy limits our downside risk if the talks collapse and the dollar strengthens on a flight to safety.
We are also watching the upcoming US Retail Sales data for May to gauge the health of the consumer. April’s figures showed a stronger-than-expected 0.4% increase, and another robust report would reinforce the Fed’s hawkish position. A weak number, however, could reignite rate cut speculation and put significant pressure on the dollar.
