All wars eventually end with a peace agreement, and investors expect the same outcome in the Middle East sooner rather than later. Expectations of de-escalation, together with the TACO trade and diverging monetary policies, are driving the EUR/USD pair higher. Let’s discuss the outlook and develop a trading plan.
The article covers the following subjects:
Major Takeaways
- Markets are rallying on expectations of de-escalation.
- The ECB remains on track for further deposit rate hikes.
- The Fed is taking a cautious approach to monetary tightening.
- A breakout above 1.1470 would provide a signal to add to EUR/USD long positions.
Weekly Fundamental Forecast for Dollar
Investors believe that despite the escalation of the conflict in the Middle East, the US and Iran will return to the negotiating table. As a result, oil prices decline, while US stock indices rise. Coupled with falling Treasury yields, this creates the ideal backdrop for a rally in the EUR/USD pair.
Markets were more encouraged by Donald Trump’s remarks that Iran had reached out to seek an agreement than by his earlier claim that the ceasefire was over. Investors have seen this pattern before: periods of escalation are followed by de-escalation and, eventually, a negotiated agreement. As history appears to be repeating itself, hopes for a similar outcome are reviving the TACO trade, lifting both stock indices and EUR/USD quotes.
Brent Crude Price and Probability of ECB Rate Hike
Source: Bloomberg.
As Brent prices rise, so do the chances of the ECB tightening monetary policy, which is supporting the euro. The futures market is 90% certain of a deposit rate hike in September and puts the probability of a second round of monetary tightening by year-end at 50%. The probability of such a scenario for the federal funds rate is lower—only about 40%. The Fed is once again lagging behind, giving bulls the upper hand.
Moreover, the minutes of the ECB’s June meeting expressed concern that the longer oil prices remain elevated, the greater the risk that inflation will spread through indirect and second-round effects. This could embed the energy shock into core inflation, as well as medium- and long-term inflation expectations, forcing the European Central Bank to respond. This is despite the eurozone economy being weaker than in 2022, when the ECB was criticized for reacting too slowly to the surge in consumer prices, and despite interest rates already being higher today.
In contrast, the Fed is in no rush to act. According to New York Fed President John Williams, certain parts of the inflation outlook are probably more benign, including tariffs and developments in the Middle East, depending on how the situation evolves. At the same time, if demand for AI continues to outpace supply, it could become another driver of higher PCE inflation.
As a result, the divergence in monetary policy between the ECB and the Fed is increasingly supporting the EUR/USD pair. Combined with market confidence in Trump’s retreat from escalation and the prospect of US-Iran negotiations, it is allowing the major currency pair to continue its steady advance.
Weekly Trading Plan for EUR/USD
However, uncertainty remains elevated, and only a breakout from the 1.1390–1.1470 consolidation range is likely to revive the EUR/USD‘s upward momentum. A decisive move above the upper boundary at 1.1470 would allow traders to add to long 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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Source: Original Article
