At first glance, monetary policy divergence appears to be effective, even amid the crisis in the Middle East. However, the cautious stance adopted by central banks in a stagflationary environment is reshaping this key driver of foreign exchange rates. Let’s analyze the situation and make a trading plan for the EUR/USD pair.
The article covers the following subjects:
Major Takeaways
- The US calls the confrontation with Iran a minor issue.
- The Trade Court ruled that Trump’s tariffs are illegal.
- The Fed may raise rates due to the conflict in the Middle East.
- Short positions can be considered if the EUR/USD pair breaks through 1.172.
Weekly Fundamental Forecast for Dollar
Donald Trump is threatening to raise tariffs on European automobiles from 15% to 25%. However, the universal tariffs have been canceled by the Supreme Court. Moreover, the 10% tariffs introduced in their place have just been ruled unlawful by the Court of International Trade. Iran is attacking US vessels, which are returning fire at the launch sites. At the same time, the US claims the ceasefire has not been violated, and Trump considers the incident “a trifle.” Are we heading for a world of chaos?
Investors are guided by traditional patterns. International politics has never been a long-term factor. All wars eventually end with a peace treaty. The key is not to miss the moment when the relevant negotiations take place. At that point, yesterday’s underdogs become the winners, and the leaders become the losers. The US dollar’s return to levels seen before the armed conflict in the Middle East suggests the markets consider it over. However, that is not the case.
G10 Currencies Since Start of Middle East Conflict
Source: Wall Street Journal.
Rabobank points to another factor behind the divergence among G10 currencies. Leading the pack are the Norwegian krone and the Australian dollar — currencies backed by central banks pursuing tighter monetary policy. The Bank of England intends to do so aggressively, which explains the pound’s third-place position in the race. As for the Fed, the futures market expects a 73% probability that borrowing costs will remain at current levels. This divergence does not benefit the greenback.
In my view, this approach resembles a funhouse mirror — it distorts reality. Aggressively raising rates during a period of stagflation is nothing more than digging a grave for your economy. The ECB and other central banks speak loudly about this, but are unlikely to do so. The Fed, however, thanks to the strength of the US economy, can afford to tighten monetary policy. The rise in inflation expectations to their highest levels since 2023 supports such a decision.
Inflation Expectations in US
Source: Wall Street Journal.
According to Minneapolis Fed President Neel Kashkari, the longer the Strait of Hormuz remains closed, the higher the likelihood of a federal funds rate hike. The logic is straightforward: rising oil prices would fuel inflation and potentially force the Federal Reserve to tighten monetary policy.
At this stage, it may be premature to write off the US dollar. Its recent weakness has largely been driven by optimism surrounding a possible end to the conflict in the Middle East, even though the situation remains far from resolved.
Weekly Trading Plan for EUR/USD
With these conditions in place, short positions on the EUR/USD pair opened on a rebound from 1.178 can be maintained and increased if the pair breaks below the 1.172 support level. This strategy would gain additional relevance if the April US employment data comes in broadly in line with forecasts.
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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