While market participants remain unsure about both Kevin Warsh’s strategy and a swift resolution of the Middle East conflict, the theme of American exceptionalism is once again taking center stage. The S&P 500 is closing in on all-time highs, the Dow Jones is already rewriting records, the Magnificent Seven has posted an unprecedented three-day gain in market capitalization, and U.S. manufacturing activity is expanding at the fastest pace in four years. Under these circumstances, the pullback in EUR/USD looks entirely logical.
Investors are gradually getting to grips with the logic behind Warsh’s plan. Its essence lies in creating a closed loop: the Fed does not tighten policy because Treasury yields are rising anyway. Treasury yields climb because the market, fearing the regulator’s passivity and a fresh inflation spike, demands an additional risk premium. The upshot is that markets watch the central bank, while the central bank watches the markets.
In my view, such a setup is workable only on the condition that the inflationary surge proves temporary. Yet events in the Middle East suggest otherwise. Donald Trump called off strikes on Iran at the last moment, claiming that the adversary and mediators had supposedly asked for negotiations. Tehran, for its part, declared that no dialogue with Washington was under way. In response, the U.S. president branded the Islamic Republic two-faced and gave it one final chance to sign a deal.
Oil reacted with gains to the familiar “escalation–de-escalation–and back again” script, but the true driver behind Brent’s rally is the blockage of the Strait of Hormuz. According to Kpler, traffic through the strait has shrunk to nine tankers, seven of which followed a route approved by Iran. The odds of full navigation resuming along the world’s main oil artery are fading, and with them the risks of further price increases are mounting.
Incidentally, Brent’s rally rather plays into the dollar’s hands, since the United States is a net exporter of energy. And that is far from the greenback’s only trump card. The artificial intelligence boom has radically transformed the American economy. The AI-fueled stock rally is boosting household wealth and stimulating consumer spending. Data-center construction is generating building orders, new jobs, and municipal tax revenues. Massive investment is feeding GDP directly.
By Oxford Economics’ estimates, absent the AI factor, U.S. economic expansion would have been a third weaker. Barclays analysts describe the current situation as an “economy largely driven by artificial intelligence.” But what happens when this boom runs out of steam?
For now, it is too early to speculate, which means American exceptionalism will continue to underpin the dollar. Short positions in EUR/USD opened around 1.154 can reasonably be added to on a break of the 1.15 support.
