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By: Editorial Team, StoneX Media
Markets rarely get to celebrate good inflation news for long. The U.S. dollar sold off sharply after annual U.S. inflation slowed to 3.5%, well below the 3.8% expected, with monthly prices posting their biggest decline in more than six years. Yet with tensions between the United States and Iran escalating and Brent crude trading around $87 a barrel, the energy market is quietly rebuilding the very price pressures the CPI report seemed to bury. That tension between cooling inflation data and rising energy costs now sits at the center of the interest rate outlook.
Fawad Razaqzada, Market Analyst at FOREX.com, has more than 12 years of trading and analysis experience across forex, indices, commodities and cryptocurrencies. Because he works across both currency and energy markets, the feedback loop between oil prices, inflation expectations and the dollar sits squarely in the territory he covers daily.
Before the inflation numbers landed, the dollar had been drawing strength from the standoff between the United States and Iran, with higher oil prices boosting demand for the greenback against lower-yielding currencies such as the Swiss franc. The CPI shock reversed that move, but Razaqzada argues the reversal rests on shaky ground. Brent crude is trading around $87 a barrel, and "if the conflict escalates further, energy prices could rise much more" [01:35]. The precedent is recent. "Earlier this year, at the height of the conflict, Brent briefly traded above $110, so we've seen how quickly the market can move when supply concerns take hold" [01:45].
"Higher oil prices would almost certainly push inflation expectations back up, which could force markets to rethink the outlook for U.S. interest rates" [02:05], Razaqzada notes, and that rethink would not hit both sides of the Atlantic equally. The euro has held up on expectations that the European Central Bank may keep policy tighter for longer, yet Europe depends far more heavily on imported energy than the United States. Consequently, if oil keeps heading toward $100 a barrel, he warns that "the drag on the eurozone economy could easily outweigh any benefit from higher ECB interest rates" [02:30]. On the charts, the EUR/USD trend remains bearish even after the pair climbed back to around 1.1450, a prior support level turned resistance, with support at 1.1410 and 1.1380 ahead of the June low of 1.1325. In his view, the bigger picture still favors the dollar if the oil rally continues.
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--- Written by Gus Farrow, Senior Manager, StoneX Media
--- Expert: Fawad Razaqzada, Market Analyst, FOREX.com
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