How geopolitical events and energy prices shape currency markets
When the conflict in Iran began, the US dollar became stronger against most major currencies. The US economy is seen as largely insulated from the conflict due to its geographical distance, and it may even benefit from higher oil prices being a net exporter. Since then, currency markets have reacted erratically to news about the conflict. Now that attacks have been reduced and talks of a deal come and go, there is less clear direction in the currency markets.
The euro’s value against the US dollar mainly depends on energy prices, especially gas. The ceasefire, and increased hopes of a permanent end to the conflict, helped the euro to recover and caused the US dollar to weaken. The exchange rate for the euro and US dollar (EUR/USD) now stands close to 1.1635, somewhat below the level when the conflict started. If people keep hoping for a deal and oil and gas prices go down, the euro could do well. But if the conflict re-intensifies, the exchange rate could drop back to 1.14.
Japanese authorities have also influenced market dynamics by intervening in the foreign exchange market to support the yen's recovery and compel traders to reduce excessive speculative positions against the currency. This affected the US dollar and the euro too as USD/JPY declined faster than EUR/USD resulting in an upward effect in EUR/USD. Japan is also very dependent on energy from abroad and therefore vulnerable when oil and gas prices are volatile.
Outlook for the euro and US dollar exchange rate
We expect that oil and gas prices will stay high, which will put pressure on the euro compared to the US dollar. However, the euro is unlikely to fall quickly because traders have already sold their euro positions. Furthermore, high energy prices have led to hawkish pivots in central banks, with most becoming more cautious or even raising rates. This should support the euro, because the European Central Bank is expected to raise interest rates soon, while the US Federal Reserve will likely keep rates the same for now.
When energy prices eventually fall, the euro should get stronger again. We expect the euro to appreciate against the US dollar at the end of this year (about 1.20) and even more by the end of 2027 (about 1.25).
Georgette Boele – FX & Oil Strategist