EUR/USD: Oil shock, real rates and conflict risks – Commerzbank

Commerzbank’s Volkmar Baur argues that an end to the Iran conflict and a reopening of the Strait of Hormuz could support the Euro against the Dollar via relative real-rate dynamics. Eurozone inflation expectations and ECB pricing are seen as more sensitive to Oil than in the US, while political developments after the Hungarian election may have structurally lifted EUR/USD.

Conflict resolution and Euro real rates

"While the oil price fell from around USD 110 per barrel to around USD 101, the euro rose by about one percent against the US dollar, while the trade-weighted USD lost 0.4%. However, we shouldn’t lose sight of the fact that, as of today, EUR/USD is already back at around 1.175. Before the conflict, we had been hovering around 1.18; at the low point, we briefly hit 1.14."

"If we now look at this in comparison to the US, it becomes apparent: Market expectations regarding the ECB do react more strongly to changes in the oil price than expectations regarding the Fed. However, expectations regarding eurozone inflation are shifting even more sharply. In the event of an end to the Iran conflict and the reopening of the Strait of Hormuz, a falling oil price would thus cause interest rates in the eurozone to fall somewhat more sharply than in the US. However, inflation expectations in the eurozone would fall even more sharply, and more so than on the other side of the Atlantic. The difference in real interest rates would therefore develop in favor of the euro and should strengthen the euro against the US dollar."

"But why, then, is EUR/USD already trending back toward pre-conflict levels today? To answer this question, we likely need to look eastward. If we examine the trajectory of EUR/USD and the yield spread on 10-year government bonds over the past 10 weeks, it becomes clear that these have diverged significantly since April 13. A look at the relationship between the oil price and EUR/USD also shows that while the oil price has maintained its influence on the exchange rate throughout the entire ten-week period, a parallel shift of about 2 cents in favor of the euro occurred over the weekend of April 11/12. Precisely the weekend of the Hungarian election."

"Victor Orban’s defeat has evidently restored the market’s faith in the EU’s ability to implement political reforms and economic measures to a certain extent, which structurally supports the euro. Consequently, I would assume that an end to the Iran conflict and a lower oil price certainly have the potential to cause the euro to appreciate against the US dollar once again."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)