Markets are weary of geopolitical surprises, Kevin Warsh’s terse commentary, and Donald Trump’s verbose statements. Investors are returning to what they understand best: monetary policy. It is precisely the expectation of hawkish rhetoric from the ECB at its July meeting that is allowing EUR/USD to rally, despite a fundamentally unfavorable backdrop for the euro. Typically, an escalation in the Middle East, falling equity indices, and rallies in oil and U.S. Treasury yields play into the hands of the U.S. dollar. But not this time.
The Oil Crisis Morphs into a Poly-Crisis
Houthi attacks on shipping in the Red Sea have pushed Brent crude above $96 a barrel, but this is just the tip of the iceberg. Blockades of the Strait of Hormuz and the Bab-el-Mandeb strait are now compounded by supply disruptions for Russian and Kazakh oil due to Ukrainian drone strikes on Black Sea infrastructure. Classical market logic suggests that such geopolitical escalation should support the dollar as a safe-haven asset, while the rally in North Sea crude should further bolster the greenback given the U.S. status as a major net exporter of energy. However, the market is choosing to look past this lens.
The Euro’s Trump Card: Inflation Dictates Tightening
The euro has its own argument that outweighs these geopolitical risks. The higher Brent climbs, the more acute inflationary risks become in the Eurozone, making tighter ECB monetary policy increasingly inevitable. While a deposit rate hike in July is not expected, the market currently prices in a 90% probability of a hike in September. The odds of two monetary tightening cycles by the end of 2026 stand at 60%. For comparison, the equivalent probabilities for the Fed are notably lower, at 77% and 56%, respectively. This divergence in expectations directly supports EUR/USD.
The ECB Under the Microscope: Time for Decisions
The European Central Bank’s meeting is the main intrigue of the coming hours. A key marker will be whether Christine Lagarde drops her previous phrasing regarding “balanced risks” for inflation; such a signal would effectively pave the way for imminent tightening. Moreover, the ECB has a runway: the Governing Council can afford to monitor developments in the Middle East until September. If Brent crude establishes itself above $100 by then, the regulator will simply have no room for maneuver other than to raise rates.
The Fed in a Zone of Uncertainty
The situation with the Federal Reserve is much foggier. The probability of a federal funds rate hike in July is estimated at just 35%, while the pause scenario sits at 65%. A gap in expectations this wide has not been seen since September 2024, when the market was guessing whether the Fed would opt for a 25 or 50 basis point move. This uncertainty deprives the dollar of its usual edge.
Trading Conclusion
With nearly a week to go until the FOMC meeting, all investor attention is fixed on the ECB Governing Council’s decision. Will the regulator meet market expectations?
In my view, the current EUR/USD rally against a negative macroeconomic backdrop is a classic execution of the “buy the rumor, sell the fact” principle. Barring a sharp geopolitical escalation, the euro’s upward move toward the $1.145–$1.147 zone, followed by a pullback below these levels, should be utilized as an opportunity to open short positions.
