Euro remains cautious as Middle East headlines, Fed outlook drive sentiment
- EUR/USD holds steady as fresh US-Iran diplomacy signals soften demand for the US Dollar.
- Additional Fed rate hike expectations keep the Greenback supported despite the pullback.
- The Euro struggles to gain traction despite a hawkish ECB outlook.
EUR/USD is little changed on Tuesday as the US Dollar (USD) gives back earlier gains following fresh diplomatic signals surrounding the war between the United States (US) and Iran. At the time of writing, the pair trades around 1.1453 after recovering from an intraday low of 1.1433, its lowest level since July 30.
The Greenback loses momentum while Oil prices also fall after Iran said it could reopen the Strait of Hormuz within seven days if Washington eases military pressure and lifts its blockade of Iranian ports. The US Dollar Index (DXY) trades around 100.40 after touching its highest level since late July earlier in the day. Meanwhile, West Texas Intermediate (WTI) Oil trades near $90 and is down more than 5% so far this week.
Markets are also watching the UN General Assembly in New York, where US President Donald Trump and Iranian President Masoud Pezeshkian are both attending. US Secretary of State Marco Rubio said on Tuesday that Washington is “open to” a meeting with Iran at the UN, but added that he does not think any meeting between Trump and Pezeshkian is currently scheduled.
Still, the US Dollar's downside could remain limited as the Federal Reserve ( Fed) keeps the door open to additional tightening. Meanwhile, the latest ADP Employment Change four-week average increased to 20K from 16.75K. The central bank raised rates by 25 basis points (bps) last week to 3.75%-4.00%, while 16 of 18 officials expect at least one more increase this year.
Boston Fed President Susan Collins said on Tuesday that “the upside risks to inflation have increased,” while labor market conditions appear “a bit stronger overall.” She added that she sees “an increased likelihood” of inflation staying notably above the Fed’s 2% target, arguing that with the labor market on firmer footing, monetary policy can focus on bringing inflation back to price stability.
Strategists at Brown Brothers Harriman argue that while “tightening by other major central banks limits policy divergence with the Fed and suggests USD will struggle to make new cyclical highs,” the currency’s underlying bias remains constructive. They highlight that “the US growth advantage relative to other major economies skews USD risk to the upside.”
On the other side of the pair, the Euro (EUR) struggles to benefit from ECB rate hike expectations as elevated Oil prices weigh on the Eurozone growth outlook, given the region’s heavy reliance on imported energy.
Analysts at MUFG note that Eurozone rate markets remain firmly priced for further tightening, with investors expecting the ECB to deliver “three to four more hikes in the year,” and assigning “over a 50:50 probability of another back-to-back hike in October.” They highlight comments from ECB Chief Economist Philip Lane to Le Temps, who warned that “we are now witnessing a second wave of price rises, not only in oil but also in gas. We believe this second wave of energy price rises should lead to higher and more persistent inflation, before a decline toward our target from mid-2027 onwards.”
ECB FAQs
The European Central Bank (ECB) in Frankfurt, Germany, is the reserve bank for the Eurozone. The ECB sets interest rates and manages monetary policy for the region. The ECB primary mandate is to maintain price stability, which means keeping inflation at around 2%. Its primary tool for achieving this is by raising or lowering interest rates. Relatively high interest rates will usually result in a stronger Euro and vice versa. The ECB Governing Council makes monetary policy decisions at meetings held eight times a year. Decisions are made by heads of the Eurozone national banks and six permanent members, including the President of the ECB, Christine Lagarde.
In extreme situations, the European Central Bank can enact a policy tool called Quantitative Easing. QE is the process by which the ECB prints Euros and uses them to buy assets – usually government or corporate bonds – from banks and other financial institutions. QE usually results in a weaker Euro. QE is a last resort when simply lowering interest rates is unlikely to achieve the objective of price stability. The ECB used it during the Great Financial Crisis in 2009-11, in 2015 when inflation remained stubbornly low, as well as during the covid pandemic.
Quantitative tightening (QT) is the reverse of QE. It is undertaken after QE when an economic recovery is underway and inflation starts rising. Whilst in QE the European Central Bank (ECB) purchases government and corporate bonds from financial institutions to provide them with liquidity, in QT the ECB stops buying more bonds, and stops reinvesting the principal maturing on the bonds it already holds. It is usually positive (or bullish) for the Euro.
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