De-escalation is underway in the Middle East, but the market is not yet pricing in a complete end to the conflict. Combined with growing uncertainty over the Fed’s upcoming rate decision, this is supporting the US dollar. Let’s discuss this topic and make a trading plan for EUR/USD.
The article covers the following subjects:
Major Takeaways
- The probability of a Fed rate hike in July is increasing.
- Investors are not rushing back to the TACO trade.
- The market is buying the US dollar on speculation.
- A break below 1.137 will be a signal to sell EUR/USD.
Weekly Fundamental Forecast for Dollar
Fear sees danger everywhere. The market is so concerned about the risk of an unexpected Fed rate hike that it is ignoring the de-escalation of the conflict in the Middle East. Negotiations between Iran and Oman on transit through the Strait of Hormuz, increased shipping traffic in the Red Sea, and Donald Trump’s statement about productive talks with Tehran should have pushed the US dollar lower. However, ahead of the FOMC meeting, uncertainty remains so high that EUR/USD has returned to the lower boundary of its 1.137–1.147 trading range.
The probability of tighter Fed monetary policy after the July 28–29 meeting has climbed to 38%. HSBC believes that if the Fed surprises the market with a rate hike, the US dollar will gain a new bullish catalyst. MUFG also argues that monetary tightening at the upcoming FOMC meeting cannot be completely ruled out. According to the bank, Kevin Warsh has insisted that inflation must return to the Fed’s 2% target, which would require decisive action.
Market Expectations for Fed Rate Changes
Source: Bloomberg.
In contrast, Citi remains convinced that the Fed will leave borrowing costs unchanged. The new Fed Chair has emphasized a data-dependent approach, and the latest employment and inflation figures suggest that policymakers should wait for more evidence before taking further action.
At the same time, markets remain skeptical that the ceasefire in the Middle East will last. Despite Donald Trump’s statements about productive talks with Iran, Tehran continues to use drones to attack Gulf countries. It would seem time to return to the TACO trade, but the ceasefire is so fragile that investors prefer to wait and see.
Time is on Tehran’s side. According to a Bloomberg report, Iran would prefer to prolong the conflict until the US midterm elections in November, expecting Donald Trump to become more willing to compromise afterward. This scenario appears plausible, as support for both the president and his party continues to decline. According to a Reuters/Ipsos poll, only one in three Americans supports military action in the Middle East. This increases the risk of Republican losses.
Approval Ratings of US Political Parties
Source: Reuters.
The United States has become deeply involved in the conflict with Iran and has few favorable options. At the same time, Tehran’s strategy of prolonging the confrontation and periodically escalating tensions is likely to keep Brent crude prices elevated, fuel US inflation, and eventually force the Fed to raise interest rates.
Weekly Trading Plan for EUR/USD
The US dollar’s rally ahead of the FOMC meeting is similar to the euro’s advance before the ECB meeting. Both are examples of the “buy the rumor” trade. For EUR/USD to continue its decline, the Fed would need to tighten monetary policy. Otherwise, the risk of selling the greenback on the news will increase. The 1.137 level is the key line to watch. A rebound from this level will provide an opportunity to open long positions in EUR/USD, while a breakout below it will support a return to 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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