The Middle East crisis has ceased to be a shock for the market and is gradually turning into the “new normal.” Investors are swinging between phases of escalation and de-escalation, frantically buying the dollar one moment and swiftly dumping it the next. However, the return of Brent crude to the $80-per-barrel mark poses a real threat of entrenched inflation at elevated levels. This gives the Federal Reserve a compelling reason to reconsider and potentially cancel entirely the three rate cuts that were planned for 2025. For EUR/USD bears, this is a welcome development.
The key to understanding the paradoxical resilience of the US economy lies in real interest rates. Given the current inflation rate, they are effectively approaching zero. This means that, despite historically high nominal borrowing costs, US monetary policy remains accommodative.
It is precisely this factor that has prompted analysts at The Wall Street Journal to revise their macroeconomic forecasts: the US GDP growth forecast for 2026 was raised from 2% in April to 2.1%, and the probability of a recession over the next year was lowered from 33% to 25%. Labor market expectations have also improved: the unemployment forecast was reduced to 4.3%, and monthly job growth was revised upward—from 45,000 to 65,000.
However, the labor market is no longer the primary inflationary driver as it was in previous cycles. Traditional economic models are failing, and the Fed is racking its brains trying to assess exactly how tariff policies, Middle East tensions, and other exogenous shocks are impacting consumer prices.
The higher inflation climbs, the more “soft” and accommodative the Fed’s current policy rate appears. This creates a solid foundation for arguing in favor of further monetary tightening. Under these conditions, Treasury yields inevitably rise, supporting the dollar. And this is where another powerful factor enters the stage—artificial intelligence.
It is not just that in the initial stages of AI deployment, companies incur massive capital expenditures on building data centers, which in itself drives up prices. The more important structural mechanism is this: tech giants (hyperscalers) are actively issuing their own corporate bonds to finance these projects. This diverts institutional investors’ capital away from the government Treasury market, forcing Treasury yields to rise even faster due to diminished demand.
Ultimately, geopolitical instability and the AI boom are forming a powerful double shield for the US currency, allowing it to maintain its leadership position in the Forex market for yet another year. Will the “bearish” camp for EUR/USD now be able to withstand the test of Kevin Warsh’s upcoming Congressional testimony and the impending release of inflation data?
