While the Fed used to assume that inflationary pressure stemmed primarily from the labor market, that has now changed. Tariffs, geopolitics, and AI are driving inflation. Let’s discuss this topic and develop a trading plan for the EUR/USD pair.
The article covers the following subjects:
Major Takeaways
- Geopolitical factors are becoming the new normal.
- AI is triggering a rally in Treasury yields.
- The Fed is forced to revise its models.
- Long trades on the EUR/USD pair can be considered if the price closes the gap near 1.141.
Weekly Fundamental Forecast for Dollar
The Middle East remains a significant source of uncertainty, yet geopolitical tensions are increasingly being treated as the new normal by financial markets. Investors oscillate between fears of conflict escalation and hopes of de-escalation—at times rushing into the US dollar as a safe haven, at others abandoning it with equal speed. Meanwhile, Brent crude’s return to $80 per barrel raises the risk that inflation will remain stubbornly elevated, strengthening the case for unwinding the three federal funds rate cuts implemented in 2025. Such a scenario would further support EUR/USD bears.
Ultimately, the economy is driven by real interest rates. With inflation at current levels, real rates remain close to zero, implying that monetary policy is still accommodative—regardless of how high nominal borrowing costs may appear by historical standards.
Fed Interest Rate and US Inflation
Source: Wall Street Journal.
This helps explain the US economy’s remarkable resilience. Economists surveyed by The Wall Street Journal have revised their 2026 GDP growth forecast upward, from 2.0% in April to 2.1%, while lowering the estimated probability of a recession over the next 12 months from 33% to 25%. They also expect the labor market to remain stronger than previously anticipated. The unemployment rate forecast has been revised down from 4.5% to 4.3%, while projected average monthly job creation has been raised from 45,000 to 65,000.
Probability of Recession in US
Source: Wall Street Journal.
However, the labor market is no longer the primary driver of inflation, as it was in previous cycles. Traditional models are proving less reliable, and the Fed is still trying to assess how tariffs, the conflict in the Middle East, and other supply-side shocks are feeding through to consumer prices.
The higher inflation climbs, the more the Fed’s current policy rate appears accommodative in real terms. That, in turn, strengthens the case for tighter monetary policy. Such an environment is supportive of the US dollar, as expectations of higher interest rates push Treasury yields upward. Artificial intelligence is also contributing to this dynamic.
In the early stages of adoption, AI investment tends to be inflationary, as companies pour capital into data centers and computing infrastructure. At the same time, hyperscalers are issuing large volumes of debt to finance these investments, diverting investor demand away from US Treasuries. The resulting increase in Treasury yields provides an additional tailwind for the dollar.
Weekly Trading Plan for EUR/USD
Geopolitical tensions and the rapid expansion of artificial intelligence are emerging as two powerful pillars of support for the US dollar, potentially allowing it to extend its dominance in the FX market for another year. The key question now is whether EUR/USD bears can maintain the upper hand ahead of Kevin Warsh’s testimony before Congress and the release of the latest US inflation data.
The week is shaping up to be exceptionally volatile. Ahead of these market-moving events, traders may find opportunities by taking advantage of sentiment swings driven by headlines about geopolitical escalation and de-escalation. One strategy is to buy the EUR/USD on a gap close toward 1.141 or, after selling on renewed Middle East tensions, reverse into long positions near the lower boundary of the 1.137–1.147 consolidation range.
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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Source: Original Article
