“Fear magnifies danger.” The currency market is so spooked by the specter of an unexpected Fed rate hike that it is demonstratively ignoring signs of de-escalation in the Middle East. One might think that news of Iran-Oman negotiations regarding the Strait of Hormuz, the revival of shipping in the Red Sea, and Donald Trump’s statements about a “productive dialogue” with Tehran would have triggered a correction in the greenback. But not so fast: ahead of the FOMC meeting, uncertainty is off the charts, and EUR/USD has once again retreated to the lower boundary of the 1.137–1.147 trading range.
The Fed at a Crossroads: Who Will Outmaneuver Whom?
The probability of monetary policy tightening following the two-day Fed meeting (July 28–29) has jumped to 38%. The views of major investment banks are divided:
- HSBC warns: if the Fed does decide to spring a surprise with a rate hike, the dollar will receive a powerful upward impulse.
- MUFG also does not rule out a tightening scenario, noting that the new Fed Chair Kevin Warsh is firmly committed to bringing inflation back to the 2% target, which may require radical measures.
- Citi, on the contrary, views the situation differently and is firmly betting on rates remaining unchanged. In their view, Warsh is demonstrating strict adherence to “data dependency,” and the latest labor market and inflation statistics point more toward a wait-and-see approach.
Geopolitics: A Fragile Truce and Tehran’s Strategic Patience
Alongside monetary dilemmas, investors are viewing the prospects for a lasting peace in the Middle East with skepticism. Despite Trump’s optimistic statements, Iran continues to deploy drones against Persian Gulf nations. The TACO strategy (Trump Always Chickens Out), which worked perfectly well in the past, is now faltering: the truce has proven too fragile, and the market prefers to sit on the sidelines.
Time is currently working in Tehran’s favor. According to Bloomberg insiders, Iran has consciously chosen a tactic of dragging out the conflict until the US midterm elections in November. The logic is simple: by that time, Trump will become much more accommodating. The approval ratings of the President and the Republican Party are inexorably falling—according to a Reuters/Ipsos poll, only one in three Americans supports military action in the region. This poses a direct threat of electoral defeat for the Republicans.
Trading Takeaway
The United States is effectively bogged down in the Iranian conflict, and no easy way out of this “quagmire” is in sight. Tehran’s strategy of stalling for time and periodically escalating tensions guarantees that Brent crude will remain at elevated levels. This, in turn, will continue to fuel inflation in the US, sooner or later forcing the Fed to implement the rate hike that the market fears so much.
