On Monday, the EUR/USD pair found itself under pressure amid an almost empty economic calendar. The downward dynamics were driven by the dollar's broad strength, which, in turn, responded to intensifying risk-off sentiment in the markets. The focus is on the Middle East again. The escalation of geopolitical tensions increased demand for the safe-haven dollar, allowing EUR/USD bears to regain the initiative and push below the support level of 1.0850 (the middle line of the Bollinger Bands indicator on the daily chart).
It is noteworthy that in the fall, especially in early October, the dollar also reacted to events in the Middle East. Traders feared a "big war," and this fear allowed dollar bulls to feel quite comfortable. The safe-haven dollar enjoyed increased demand – in just two days, the EUR/USD pair dropped by 150 points.
As of today, market participants are more restrained in their assessments, although recent events are no less "hot." In particular, we found out that Israel has begun an invasion of the southern part of the Gaza Strip. According to AFP correspondents, dozens of Israeli tanks, armored personnel carriers, and bulldozers have advanced deep into the sector near the city of Khan Yunis and reached the highway that runs through the entire sector, connecting its northern and southern parts.
In addition, according to information from the US Central Command, the US Navy destroyer "Carney" detected a ballistic missile launched from areas in Yemen controlled by the Houthis towards a cargo ship flying the flag of the Bahamas. The missile fell near the ship. Shortly after, the destroyer shot down an approaching drone (although it is not clear whether the destroyer was its target). In turn, Houthi rebels in Yemen claimed responsibility for the attack on two merchant ships in the Red Sea. Movement representatives stated that they attacked "two Israeli ships" in the Bab al-Mandab Strait.
Such events could not go unnoticed: the US Dollar Index returned to the 103 figure area and set a one-and-a-half-week high. The EUR/USD pair headed towards the base of the 8 figure. Bears are trying to settle below the 1.0850 target – this will allow them to count on conquering the 7 figure in the near future.
However, we should emphasize that the current decline is an emotional market reaction to the escalation of geopolitical tension. Typically, such fundamental factors do not last long: once the emotions subside, the bearish momentum will fade, and the bulls may regain the initiative.
If we move past geopolitics and turn to "classic" fundamental factors, the general picture is no longer in favor of the U.S. dollar. A recent example is Federal Reserve Chair Jerome Powell's speech on Friday. On the one hand, he mentioned that it is "too early" to talk about a rate cut. On the other hand, he acknowledged that the tight monetary policy is slowing down the economy, and the interest rate is currently on "restrictive territory." Although Powell repeated the routine phrase that the Fed is ready for further tightening of monetary policy "if deemed appropriate," market participants are confident that the current cycle of interest rate hikes is already over. Moreover, traders are gradually becoming more certain that the Fed will begin easing monetary policy in the spring of next year.
According to the CME FedWatch Tool, the probability of a rate hike in December is currently 0%, and in January, it is 2%. Simultaneously, the probability of a 25 basis points interest rate cut after the May meeting is 44%, and a 50 basis points cut is 38%.
During Friday's speech, Powell did not rule out the possibility of easing monetary policy in the next six months; he merely noted that this issue is not currently on the agenda. However, some of his colleagues, especially Christopher Waller, a member of the Board of Governors, are already discussing the conditions for a rate cut. According to Waller, the central bank will find it challenging to justify maintaining the status quo if inflation consistently slows down for "three, four, five months." It's worth mentioning that recent inflation reports reflected a slowdown in U.S. inflation in November – notably, the Consumer Price Index and the Producer Price Index. The core PCE index falls behind a bit (we learned the October value last week), but it also reflected a consistent downward movement.
Therefore, we should be cautious with the current momentum. Traders reacted to the rise in risk aversion and an increase in manufacturing orders in the U.S. in October (the only somewhat important report on Monday was published at the start of the U.S. session). However, geopolitical factors themselves are quite volatile and fleeting – recall the dynamics of EUR/USD in October. As for the macroeconomic report, things are not entirely smooth here either: the order volume increased by 3.6%, but this is the lowest reading since April 2020.
All this suggests that at the moment, it would be better to adopt a wait-and-see position, as it seems unreliable to sell the pair, and it wouldn't be wise to talk about buying just yet.