Slowing inflation in Europe and the escalating conflict in the Middle East suggest that the ECB will likely require additional data before making policy decisions. At the same time, hawkish rhetoric could continue to support the EUR/USD pair. Let’s examine the key drivers and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- Investors are in no rush to sell the US dollar.
- Stabilizing oil prices do not necessarily signal a slowdown in PCE inflation.
- The euro could gain support on expectations of a hawkish ECB.
- A rebound from the 1.147 level could present a selling opportunity.
Weekly Euro Fundamental Forecast
As tensions between the US and Iran continue to rise, oil prices are rising, and the US stock market is showing little reaction to geopolitical developments, so there is no need to sell the dollar. The cost of hedging against greenback volatility has reached its lowest level since December. Volatility in the Forex market is falling, which, combined with stock indices near record highs, is allowing carry trades to thrive. This involves selling low-yielding currencies against high-yielding ones—a strategy that bears are effectively exploiting on the EUR/USD pair.
US Dollar Volatility Index
Source: Bloomberg.
Despite the increase in the deposit rate from 2% to 2.25% in June, the spread with the federal funds rate remains wide, providing an opportunity for carry traders to profit. Meanwhile, the ECB is expected to pause in July. Lower-than-expected inflation in the eurozone and the escalation of the conflict in the Middle East suggest that more data is needed before making decisions.
The spread will remain wide, which does not help EUR/USD quotes. On the other hand, markets are rising on expectations. Signals from the ECB regarding monetary tightening in September could boost the euro.
However, this is unlikely to be enough to dampen the enthusiasm of US dollar bulls. The recent US military casualties have prompted fresh airstrikes, and the further both sides climb the escalation ladder, the more difficult it becomes to contain the conflict. Brent crude has returned above $90 per barrel for the first time since early June. Even if oil prices stabilize at current levels, that does not necessarily mean inflationary pressures will ease. Unlike the crude oil market, refined petroleum products lack key stabilizing mechanisms, such as releases from strategic reserves or weaker Chinese import demand. At the same time, Ukrainian drone strikes on Russian refineries continue to spur gasoline and diesel prices.
US Gasoline and Crude Prices
Source: Wall Street Journal.
High inflation has firmly taken hold in the US. That implies interest rates will stay higher for longer, limiting the US dollar’s downside from current levels. Even so, there are a few important nuances.
If inflation can’t be beaten, it can at least be measured differently. The Bureau of Labor Statistics (BLS) is revising its methodology for calculating the Personal Consumption Expenditures (PCE) price index. Under the current approach, the index places excessive weight on the costs of investment management and software development services. Reducing their share could lower the reported PCE reading by around 0.2 percentage points. Investors are expected to see the impact of these changes when the August data is released in September. For now, the EUR/USD pair is driven primarily by geopolitical developments, the upcoming ECB meeting, and inflation trends.
Weekly EURUSD Trading Plan
Expectations of hawkish rhetoric from the European Central Bank could lift the euro toward the upper boundary of the 1.137–1.147 consolidation range, or even trigger a breakout above it. However, if EUR/USD quotes fail to settle above 1.147—or if the market shifts to a classic “buy the rumor, sell the news” reaction—it could present an attractive opportunity to establish short positions.
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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