EUR/USD weakened on Monday as easing hopes of a US-Iran peace arrangement gave way to fresh strain in the Middle East. The pair traded near 1.1626, down nearly 0.30% on the day. Iran’s Tasnim reported Tehran had halted message exchanges with Washington, citing Israel’s ongoing military actions in Lebanon against Hezbollah. Separately, Iran accused the US of breaching a ceasefire after US Central Command said it conducted “self-defense strikes” on Iranian radar and drone sites, while the Revolutionary Guard said it struck an air base used by US forces in retaliation for an attack on southern Iran.
The US Dollar and oil prices rebounded in response. The US Dollar Index was around 99.20, after recovering from a two-week low near 98.75 hit on Friday, and WTI climbed more than 5% to about $92.50. Rate expectations also underpinned the Greenback, with the CME FedWatch Tool showing a 42% probability of a 25-basis-point rise in December. In Europe, markets fully price an ECB hike later this month, while higher energy costs add to Eurozone growth risks. US data showed S&P Global’s manufacturing PMI at 55.1 in May versus 54.5, and ISM’s index at 54.0, its highest since May 2022. Traders await Eurozone inflation on Tuesday and US ADP and NFP figures later in the week.
Flight To Safety Supports The US Dollar
Given the renewed geopolitical tensions, we see a classic flight to safety, which is boosting the US Dollar. The dollar’s strength is a primary theme we will be trading on in the coming weeks. We believe this environment makes it difficult to hold riskier currencies.
Implications For The Euro And Trading Strategies
This situation makes the Euro particularly vulnerable, as the Eurozone economy is highly dependent on energy imports and is threatened by soaring oil prices. Therefore, we are looking at strategies that benefit from a falling EUR/USD exchange rate. Buying put options on the EUR/USD offers a clear way to gain downside exposure while strictly defining our maximum risk.
We have seen implied volatility in currency options spike, with the EUR/USD 1-month volatility climbing over 20% in the last week alone to 8.1%. This is reminiscent of the market reaction during previous geopolitical shocks that caused sharp moves in energy prices. This rise in expected price swings reinforces our view that holding protective options positions is prudent.
We also anticipate the Federal Reserve will be forced into a more aggressive stance to fight the inflationary effects of oil hitting a 9-month high of $92.50 per barrel. If this week’s Nonfarm Payrolls data comes in strong, with economists currently forecasting the addition of 195,000 jobs, it will likely solidify the case for a rate hike. This growing policy divergence with the European Central Bank supports our bearish outlook on the euro.
