Middle East energy disruption shifts EUR/USD risks to the downside - Danske

Before the US-Iran conflict, EUR/USD took a run at the 1.2000 level as upside risks looked more likely to win out as we started the year. But in the last two weeks, the script has completely flipped amid surging energy prices globally. In particular, European gas has also surged higher in following oil prices as Iran threatens further disruption in the Gulf region.

That has not only seen the dollar come back into favour but is also weighing on the euro amid higher energy prices. That might prove to be a drag on economic activity in the region, which until recently had looked rather resilient in trying to complete the recovery path. That is now dashed and traders have to recalibrate their bearings again.

Danske Bank is one to note that the balance of risks have now shifted to the downside for EUR/USD, adding that they would take up a short position in the pair with eyes on the 1.1200 level next.

"We think the Middle East energy shock shifts the EUR/USD outcome space also beyond the first-order terms-of-trade effect. We now recommend a tactical short EUR/USD spot position with a horizon of 1-3M with a target of 1.1200. We acknowledge that the interest rate differential between EUR and USD has narrowed notably in favour of the former, but we do not expect this to last. In our view, the ECB is very unlikely to hike against a pure supply shock especially, when longer-term inflation expectations remain little changed."

As seen from the chart above, the 1.1500 level is now the key line in the sand for the currency pair. That was what held the previous drop in November last year. As such, a firm break below that could really set off a trigger for much lower levels without much technical support in sight.

The 1.1200 mark seems plausible, with the 100-week moving average not too far away at 1.1167 currently.