EUR/USD outlook undermined by crude oil resurgence

Crude oil and bond markets are flashing warning signs for risk assets. Yet, investors seem remarkably relaxed. However, if the current situation doesn’t improve markedly, we could see stock markets stage a bit of a correction and in the FX space risk-sensitive currency pairs could take a dip. With that in mind, the risks to the near-term EUR/USD outlook remain titled to the downside. With CPI still a day away, all the focus is on crude oil and US-Iran headlines.

 

Crude oil remains the key risk for EUR/USD outlook

 

Crude oil prices have surged in the last few days because the Strait of Hormuz remains effectively shut, and there are no signs of progress between the US and Iran.

 

Oil prices have been rising sharply in the last few days. Today, they were up more than 2% earlier, with Brent briefly reaching around $89 dollars a barrel, before giving back some of those gains.

 

 

The latest headlines around talks between Oman and Iran provided some relief, but we shouldn’t confuse talks with an actual breakthrough. Indeed, Iran has come out saying that the Strait of Hormuz will remain shut until their conditions are met.

 

But current standings from both the US and Iran suggests any potential deal is still some way off, meaning risks remain skewed to the upside for oil prices and to the downside for EUR/USD.

 

Concerns about supply shortages are also evidenced in oil inventories data in the US, where crude stockpiles are now at their lowest level in more than four decades.

 

If oil (and gas) prices continue to push higher, this will be bad news for energy importing regions like the eurozone, making the EUR/USD outlook somewhat bearish.

 

Don’t forget about the bond markets

 

On top of the US-Iran situation, the prospect of the Fed keeping rates high — or even tightening policy in September — is still on the table. Yet equity markets, including the German DAX index, have barely flinched. The DAX hit a new all-time high earlier today, before coming off its highs a few moments ago.  So, is the market underestimating the risks?

 

There is also the persistent warning sign in the bond market. Yields, which have been rising alongside oil prices, during the US-Iran war, have remained consistently high across the curve.

 

If crude continues higher, investors could start worrying about another inflationary shock. That could push yields even higher, putting pressure on bond prices, and ultimately make equities much less attractive - especially growth stocks. That could also be bad news for foreign currencies, especially those where interest rates are already lower compared to the US, or those where the economy relies on energy imports – such as the euro.

 

Technical EUR/USD outlook and key levels to watch

 

The EUR/USD was holding around 1.1550 handle at the time of writing, but the directional bias is far from clear. Volatility in this pair has been shocking low for a while now. It is not just because of the summer months, although clearly this is also contributing to subdued trading activity.

 

 

The pair broke its bearish trend line a few days ago, yet there has been little desire to bid up the exchange rate meaningfully from here by the bulls. That’s understandable because we have the all-important inflation data coming up and not to mention the ongoing oil market uncertainty.

 

Perhaps it makes sense to trade this EUR/USD from one level to the next and moving on to the next opportunity in these circumstances.

 

Key short term resistance is between 1.1575 to 1.6000 area. The most recent high comes in at 1.1622, where we also have the 200-day average converging. A break above that zone would thus be a bullish technical development.

 

Support meanwhile is seen around 1.1500-1.1520 area. Below this 1.1470ish and 1.1410 are the next downside targets, followed by the recent lows near 1.1350.

 

In summary

 

So, the EUR/USD outlook looks far from certain. For now, it is in a holding pattern ahead of US CPI. But if oil prices keep rising and bond yields continue climbing, the downside risks could become more pronounced - especially if US CPI also turns out to be hotter than expected.

 

In the slightly longer term outlook, the big question is whether the EUR/USD can continue looking through higher oil prices — or whether bonds eventually trigger the correction investors have been largely ignoring.

 

 

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R