EUR/USD fell for a fifth straight day and traded near 1.1650 in Asian hours on Friday. The drop came as the US Dollar rose on higher inflation linked to Middle East tensions and expectations that the Federal Reserve may keep rates high for longer.
US Retail Sales rose 0.5% month on month in April, matching forecasts and slowing from 1.6% in March. Sales were up 4.9% year on year, above the 3.3% estimate.
The US Dollar also drew support from changes in Federal Reserve leadership. Stephen Miran resigned from the Board of Governors, and Kevin Warsh is set to take over as Fed Chair.
EUR/USD losses may be limited if Euro inflation pressures rise as hopes for a durable US-Iran peace deal fade. This keeps the Strait of Hormuz effectively closed and supports higher energy costs in the Eurozone.
Money markets price in a European Central Bank rate rise in June, with three increases almost fully priced in by end-2026. ECB official Martins Kazaks said rates may need to rise if higher crude prices feed into inflation expectations.
With EUR/USD trading at 1.1650, the immediate trend suggests continued dollar strength. The latest US CPI data from April showed inflation at 4.1%, beating expectations and reinforcing the case for a hawkish Federal Reserve. We see markets now pricing in a 40% chance of another rate hike by September, a significant jump from last month.
The appointment of Kevin Warsh as the next Fed Chair adds fuel to this fire, as he is widely viewed as more aggressive on inflation than his predecessors. This leadership change likely means the bar for cutting rates is now extremely high, encouraging traders to position for a stronger dollar over the medium term. Derivative traders might consider buying put options on the EUR/USD to profit from further declines.
However, the downside for the pair isn’t a one-way street, as the European Central Bank is also feeling the heat from inflation. With the latest Eurozone HICP data showing inflation at 3.5% and crude oil prices elevated, the ECB is poised to hike rates in June. This growing hawkishness from the ECB could provide a floor for the euro, preventing a complete collapse.
We saw a similar dynamic back in 2014-2015 when policy divergence sent the EUR/USD tumbling from near 1.40 to almost parity. While the current trend echoes that period, the key difference today is that both central banks are tightening, which could create significant volatility. Traders might look at buying straddles to capitalize on sharp price swings, regardless of the ultimate direction.
Given these conflicting pressures, a defined-risk strategy like a bear put spread on the EUR/USD could be appropriate for the next few weeks. This would involve buying a put option at a higher strike price, like 1.1600, and selling another put at a lower strike, perhaps 1.1450. Such a position profits if the pair continues its decline but caps both the potential gain and the initial cost.
