EUR/USD Undermined By Crude Oil Resurgence Ahead Of CPI

In recent days, crude oil and bond markets have been flashing warning signs for risk assets. Yet, investors seem remarkably relaxed. However, if the current situation doesn’t improve markedly, we could see stock markets stage a bit of a correction and in the FX space risk-sensitive currencies, as well as those where the economy relies on energy imports could take a dip. With that in mind, most of the focus is on crude oil and US-Iran headlines, while the CPI may only trigger a temporary move in the dollar today.

Energy could replace data as the key driver for euro

A lot of attention is on the energy markets again. Crude oil prices have surged in the last few days because the Strait of Hormuz remains effectively shut, and there are no signs of progress between the US and Iran. Though reports today from Pakistan suggest that the so-called US-Iran memorandum of understanding deadline could be extended, this is not to say it will be. Indeed, oil prices have been rising sharply in the last few days, even if some headlines around talks between Oman and Iran have provided some relief here and there. But we shouldn’t confuse those talks with an actual breakthrough. Yesterday, Iran said that the Strait of Hormuz will remain shut until their conditions are met. 

So, the current standings from both the US and Iran suggests any potential deal is still some way off, meaning risks remain skewed to the upside for oil prices and to the downside for EUR/USD. 

Concerns about supply shortages are also evidenced in oil inventories data in the US, where crude stockpiles are now at their lowest level in more than four decades.  If oil (and gas) prices continue to push higher, this will be bad news for energy importing regions like the eurozone and the single currency. 

What is expected from CPI data?

US CPI is now arguably the most important event on this week’s economic calendar, due later today. The previous CPI report had certainly surprised to the downside. Headline inflation slowed more sharply than expected to 3.5% from 4.2%, while core CPI eased to 2.6%. This time, economists expect moderate weakness. Headline CPI is expected to rise 0.1% month-on-month, taking the annual rate to 3.4%. Core CPI is forecast to increase 0.2% on the month, leaving annual core inflation at 2.5%.

The question now is whether we will see that moderation, and if so, whether it is enough to trigger further dovish repricing in US dollar. But as mentioned, alongside data it is also the developments in oil prices which will determine whether expectations for a tighter Fed are rebuilt or continue to unwind.

Let’s not forget the bond markets

On top of the US-Iran situation, the prospect of the Fed keeping rates high — or even tightening policy in September — is still on the table. Yet equity markets, have barely flinched. The DAX hit a new all-time high earlier today, raising the questions about whether the market is underestimating the risks?

There is also the persistent warning sign in the bond market. Yields, which have been rising alongside oil prices, during the US-Iran war, have remained consistently high across the curve.  If crude continues to push higher, investors could start worrying about another inflationary shock. That could push yields even higher, putting pressure on bond prices, and ultimately make equities much less attractive - especially growth stocks. That could also be bad news for foreign currencies, especially those where interest rates are already lower compared to the US, or those where the economy relies on energy imports – such as the euro.

EUR/USD key levels to watch 

The EUR/USD was holding just below 1.1550 area at the time of writing, but the directional bias is far from clear. Volatility in this pair has been shockingly low for a while now. It is not just because of the summer months, although clearly this is also contributing to subdued trading activity. 

The pair broke its bearish trend line a few days ago, yet there has been little desire to bid up the exchange rate meaningfully from here by the bulls. That’s understandable because we have the all-important inflation data coming up and not to mention the ongoing oil market uncertainty. 

Perhaps it makes sense to trade this EUR/USD from one level to the next and moving on to the next opportunity in these circumstances. 

Key short term resistance is between 1.1575 to 1.6000 area. The most recent high comes in at 1.1622, where we also have the 200-day average converging. A break above that zone would thus be a bullish technical development. 

Support meanwhile is seen around 1.1500-1.1520 area. Below this 1.1470ish and 1.1410 are the next downside targets, followed by the recent lows near 1.1350.

In short 

For now, the EUR/USD is in a holding pattern ahead of US CPI. But if oil keeps rising and bond yields continue climbing, the downside risks could become more pronounced - especially if US CPI also turns out to be hotter than expected. 

In the slightly longer term outlook, the big question is whether the EUR/USD can continue looking through higher oil prices — or whether bonds eventually trigger the correction investors have been largely ignoring.