The Fed watches the markets, and the markets watch the Fed. A sustained rise in Treasury yields could help the Fed curb inflation without additional policy tightening—but only under certain conditions. The odds of that scenario unfolding remain low. Let’s examine the situation and develop a trading plan for the EUR/USD pair.
The article covers the following subjects:
Major Takeaways
- Kevin Warsh is creating a negative feedback loop.
- The chances of the Strait of Hormuz reopening are dwindling.
- American exceptionalism is propping up the dollar.
- Short positions on the EUR/USD pair can be opened if the price breaks through 1.150.
Weekly Fundamental Forecast for Dollar
As investors question Kevin Warsh’s strategy and grow less optimistic about a swift resolution to the conflict in the Middle East, American exceptionalism is once again dominating the markets. The S&P 500 is approaching record highs, the Dow Jones is setting fresh records, the Magnificent Seven have posted their largest three-day increase in market capitalization on record, and the US manufacturing PMI is expanding at its fastest pace in four years. Against this backdrop, it is hardly surprising that EUR/USD quotes are retreating.
Investors are also beginning to understand the logic behind Warsh’s approach. His strategy relies on a feedback loop: the Fed refrains from raising interest rates because Treasury yields are already climbing, while Treasury yields continue to rise as investors demand a higher risk premium amid concerns that the Fed’s restraint could allow inflation to accelerate. In this environment, the markets are watching the Fed, and the Fed is watching the markets.
Fed Interest Rate and US Treasury Yield
Source: Bloomberg.
This strategy could work if the inflationary pressure proves temporary. However, recent developments in the Middle East suggest otherwise. Donald Trump reportedly called off planned strikes against Iran at the last minute after intermediaries urged renewed negotiations. However, Tehran denied that any talks with Washington were underway. In response, the US accused Iran of acting in bad faith and warned that the opportunity to reach an agreement was running out.
Oil prices have resumed their familiar pattern of rising with escalating tensions and easing during periods of de-escalation. This time, the rally in Brent is being driven primarily by disruptions to shipping through the Strait of Hormuz. According to Kpler, tanker traffic through the strait has fallen to just nine vessels, seven of which used routes approved by Iran. As the prospects for restoring normal shipping diminish, the risks of further supply disruptions—and higher oil prices—continue to increase.
Probability of Strait of Hormuz Being Opened
Source: Bloomberg.
The rally in Brent crude also supports the US dollar, as the United States is a net energy exporter. However, higher oil prices are only one of the greenback’s advantages. The AI boom has become a powerful driver of the US economy. Rising equity markets have boosted household wealth and consumer spending, while the construction of data centers has spurred investment, job creation, and local tax revenues. Together, these factors are supporting stronger GDP growth.
According to Oxford Economics, US economic growth would be roughly one-third slower without the AI boom. Barclays likewise argues that AI has become a key engine of the economy. The question is what happens when that momentum begins to fade.
Weekly Trading Plan for EUR/USD
It is still too early to count on that, so American exceptionalism will continue to support the dollar. Short positions established at 1.154 on the EUR/USD pair can be increased if the price pierces the support level of 1.150.
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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