EUR/USD forecast: Oil dominates agenda ahead of US CPI

At the time of writing, the EUR/USD was struggling to find a clear direction. Hardly a surprise, truth be told, ahead of such an important data release. Investors are weighing a renewed surge in crude oil prices in recent days against the prospect of another important US inflation reading. While market volatility remains subdued, the combination of higher energy prices and elevated bond yields is becoming increasingly difficult to ignore. For the EUR/USD forecast to improve, energy prices will need to fall and rapidly so. This looks unlikely. The upcoming CPI report could provide some short term volatility, but it remains to be seen how much of a change there will be in the September rate cut odds, currently a coin toss.

 

Crude oil drives sentiment

 

Looking at equity markets, investors remain remarkably unmoved by recent gains in oil. For me, the concern is that oil prices could continue rising if there is no meaningful progress between the US and Iran. That could reignite stagflation concerns and lead to unwanted policy tightening. The Strait of Hormuz remains effectively closed. And the longer it remains closed the higher oil prices are likely to go. While reports of progress in discussions involving Oman and Iran have been welcomed, Iran has also indicated that the strait will remain shut until its conditions are met by the US.

 

For the EUR/USD forecast, this is a tricky backdrop. The eurozone is heavily dependent on imported energy, meaning a sustained rise in oil and gas prices could worsen the region’s inflation outlook while weighing on economic growth. That creates a potential headwind for the euro.

 

Meanwhile, US crude inventories provide another reason for caution. Stockpiles have fallen to their lowest level in more than four decades, adding to concerns that supply shortages could amplify the impact of the geopolitical disruption. We will have some fresh inventories data due later today. Let’s see if there any more drawdowns.

 

CPI likely to move the dollar only temporarily

 

US CPI remains the main scheduled event for markets today. The previous report surprised significantly to the downside, with headline inflation slowing to 3.5% from 4.2%.

 

Economists are expecting a more modest improvement this time. Headline CPI is forecast to rise 0.1% month-on-month, leaving annual inflation at 3.4%, while core CPI is expected to increase 0.2%, keeping the annual rate at 2.5%, down from 2.6% previously.

 

A softer-than-expected reading could reinforce expectations for a less hawkish Fed and put renewed pressure on the dollar. But if the inflation data is in line or stronger than expected, then the dollar can remain supported.

 

The dollar’s reaction to CPI may fade fast in any event, especially if the data does not deviate too much from expectations. A lot will depend on what happens to oil prices. If crude continues climbing, markets may start rebuilding expectations for tighter US monetary policy, even if the inflation data itself is relatively benign.

 

Bond yields are flashing a warning

 

The other part of the equation is the bond market. Treasury yields have remained elevated as oil prices have risen, reflecting concerns that the energy shock could eventually feed into broader inflation.

 

So far, equity investors appear largely unconcerned. But if crude moves substantially higher from here, the combination of rising inflation expectations and higher yields could become increasingly uncomfortable for risk assets.

 

That would also create an additional headwind for the euro, particularly given the relatively lower interest-rate environment in the eurozone and the region’s exposure to imported energy.

 

EUR/USD levels to watch

 

At the time of writing, the EUR/USD was trading just below 1.1550. The directional picture still looks uncertain. Volatility has remained remarkably low, partly reflecting the summer trading environment and partly the market’s wait-and-see approach ahead of CPI.

 

 

Technically, the pair recently broke above a bearish trend line, but buyers have so far failed to generate meaningful follow-through. That is a sign of weakness.

 

Resistance begins around 1.1575, with the recent high at 1.1622 also important. The 200-day moving average is converging around that area, making a break above it a potentially significant bullish signal to watch out for in the coming days.

 

On the downside, initial support is located around 1.1500–1.1520. A break below that zone would expose 1.1470 and then 1.1410, with the recent lows around 1.1350 becoming the next major downside reference.

 

EUR/USD forecast summary

 

For now, EUR/USD remains caught between a potentially softer US inflation backdrop and an increasingly uncomfortable energy story.

 

If CPI comes in cooler and oil prices stabilise, the euro could regain momentum. But if crude continues higher, bond yields follow, and US inflation proves sticky, the risks could quickly turn more negative.

 

Another key question is whether the EUR/USD can continue looking through higher energy prices — or whether the bond market eventually forces investors to reassess the risks they have so far largely ignored. All told, the EUR/USD forecast remains tilted slightly lower.

 

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R