EUR/USD outlook undermined further by US-Iran escalation

• EUR/USD forecast remains uncertain as renewed US-Iran tensions sends oil higher
• FOMC minutes coming up but market’s attention is on developments in the Middle East again
• EUR/USD selling contained relative as it holds inside bear flag

 

Oil returns to the forefront of currency markets

 

The EUR/USD edged only slightly lower, showing surprising resilience for now while European equity markets took the brunt of the sell-off, as tensions in the Middle East made an unwelcome return with renewed intensity. A sharp rebound in crude oil prices has quickly become the dominant market theme again, overshadowing economic data and forcing investors back into defensive positions.

 

Will tensions de-escalate quicker this time?

 

Well, it is tough to say. Already, Trump has announced they will probably strike Iran again tonight. There will be retaliation from Tehran and things could get quite messy very quickly. Trump’s latest comments certainly don’t point to any de-escalation after he effectively dashed hopes that recent diplomatic progress could continue, reviving concerns over potential disruptions to global energy supplies.

 

Whether events develop into a prolonged confrontation remains uncertain. There is still scope for political rhetoric to soften over the coming days, but for now traders are once again having to price in geopolitical risk. That naturally favours the US dollar while simultaneously weighing on risk-sensitive assets, including European equities and the euro. Europe also relies heavily on energy imports, which makes the euro even more vulnerable.

 

The prospect of renewed disruption around the Strait of Hormuz also keeps stagflation risks firmly on investors’ radar. Higher energy prices would complicate the outlook for central banks at a time when many had been preparing for a more benign inflation environment.

 

EUR/USD forecast: US rates expectations remain supportive for dollar

 

Against this backdrop, the publication of the latest Federal Reserve meeting minutes may struggle to attract its usual level of attention. Markets already have a fairly clear understanding of the Fed’s position, with policymakers remaining cautious about inflation risks.

 

If oil prices remain elevated, inflation expectations could become more persistent, giving the Fed more reason to keep policy restrictive for longer, and deliver some rate hikes later this year. That view continues to support US Treasury yields, maintaining one of the dollar’s strongest advantages over its major counterparts. This explains why, despite relatively resilient European economic data, investors have continued to favour the greenback lately.

 

EUR/USD technical analysis: bear flagging

 

From a technical perspective, the EUR/USD forecast continues to point lower, even if we haven’t seen an immediate drop amid the geopolitical uncertainty yet. But with the pair showing a potential bear flag in the making, the pressure remains.

 

 

The 1.1400 area remains an important near-term support level to watch on the daily EUR/USD chart. A decisive break beneath that zone would expose the 1.1300 handle.

 

On the upside, resistance around 1.1450 continues to cap advances. A sustained move above that level would shift attention towards the psychological 1.1500 mark, with 1.1575 representing the next significant upside objective.

 

In summary 

 

For the time being, however, the fundamental backdrop offers little justification for a sustained recovery. Unless incoming US economic data begins to weaken convincingly or expectations surrounding Fed policy changes materially, say as a result of significantly weaker oil prices (again, unlikely), the dollar’s combination of higher yields and safe-haven demand is likely to keep rallies in EUR/USD relatively limited. That leaves the broader EUR/USD forecast cautiously bearish over the near term.