Euro: De-escalation risk weighs on EUR against US Dollar – Commerzbank

Commerzbank’s Thu Lan Nguyen discusses EUR/USD in light of rising hopes for de-escalation in the Middle East. She notes the US Dollar (USD) has gained as rate expectations shifted in favor of the United States, with Euro Area inflation seen more energy-sensitive. Both European Central Bank (ECB) and Federal Reserve (Fed) are expected to hike once more, but improved US–Iran relations and lower energy prices could pressure EUR/USD further.

Dollar gains as rate views shift

"Against this backdrop, the US dollar gained ground against the euro yesterday. The main driver was a shift in interest rate expectations: the market-implied interest rate differential between the US and the euro area moved in favour of the dollar. Ultimately, this reflects the market's view that inflation and monetary policy in the euro area are more heavily influenced by energy prices than in the United States."

"We currently expect both the ECB and the Fed to deliver one additional rate hike by year-end. The key question, however, is whether both central banks would stick to that course if a potential rapprochement between the US and Iran were to trigger a significant correction in energy prices."

"The market reaction so far suggests that investors expect the ECB to adopt a more cautious stance than the Fed in such a scenario. However, that is far from certain. It should not be forgotten that, this time around, the Fed was slower than the ECB to respond to rising inflation pressures."

"Nevertheless, if relations between the US and Iran continue to improve and energy prices consequently correct markedly lower, EUR/USD could come under further downward pressure in the near term. Whether such a move would prove sustainable, however, is open to question."