The EUR/USD pair continues to react sensitively to fluctuations in oil prices, but traders’ main focus is now on Kevin Warsh’s upcoming speech in Bangkok. Previously, this influential Fed policymaker, with his “hawkish” statements following the June and September FOMC meetings, as well as at the Jackson Hole symposium, effectively kicked off the rally in the US currency. However, in July, he abruptly changed his rhetoric, stating that financial markets are capable of doing part of the regulator’s job. Will he repeat this unexpected maneuver at the end of the current week?
Warsh can rightfully be called a financial trendsetter. His thesis that high bond yields themselves provide sufficient tightening of financial conditions, sparing central banks from aggressive action, has found widespread support. The Bank of England, for instance, refrained from raising its key rate at the last meeting, citing that market mechanisms already create the necessary level of monetary restriction. The ECB took a similar stance, noting in its September minutes that market conditions can independently adjust the trajectory of monetary policy.
Following this logic, current 18-year highs in global debt market yields could indeed free regulators from active intervention. Monetary policy has little effect on energy prices, whereas a drop in Brent quotes would automatically lower both inflation expectations and government bond yields. We saw a similar scenario in 2023: after the Fed completed its tightening cycle, market rates continued to rise, but the regulator itself refrained from hikes, which ultimately led to a 120 basis point drop in the yield of 10-year Treasury bonds in just two months. Could this mechanism of inaction work again now?
However, this theory has three significant vulnerabilities. First, unlike the situation three years ago, inflation has not yet returned to target levels. Second, the passivity of regulators risks undermining trust in them, which could lead to uncontrollable market behavior (as Alan Greenspan aptly described, markets sometimes act on pure instinct, reacting to their own reflection). And third, there is no guarantee that oil prices will actually decline.
Moreover, the escalation of tensions in the Middle East looks for Iran like almost the only way out of the dead end it has created for itself. This logically pushes Brent prices up, which in turn drags Treasury yields along with it. The International Monetary Fund (IMF) has already identified the sharp rise in bond yields as the main threat to the stability of the global financial system. Against the backdrop of growing risks of a systemic crisis, investors are naturally seeking refuge in the traditional safe haven—the US dollar.
In conclusion, the EUR/USD pair may face a real “roller coaster” in the coming days. Any decline on the back of inflation data could trigger profit-taking due to fears of hearing a “dove” surprise in Kevin Warsh’s speech. Until the Consumer Price Index (CPI) report is released, the most sensible strategy for traders appears to be maintaining a neutral stance and staying out of the market.
