22.05.202616:33 Forex Analysis & Reviews: Dollar braces for storm

Progress exists, but it is of futile importance. The White House is finally starting to admit the obvious — Iran cannot be brought to its knees by threats. It won't give up its uranium stockpiles or control over the Strait of Hormuz. More effective measures are needed, so Saudi Arabia's, the UAE's, and Qatar's pleas to the US not to resume air strikes matter a lot. Escalation of the geopolitical conflict in the Middle East appears unavoidable. That means EUR/USD's fate is largely sealed.

At the summit of G7, central bank governors and finance ministers concluded that the inflation spike will be temporary. We are not expected to face the double-digit consumer price surge seen four years ago. Higher global debt yields compared with 2022 are a result of stronger economies than those back then.

Dynamics of inflation and global debt yields

All that may be true, but against the backdrop of rapidly depleting global oil stocks, a Middle East escalation is a direct route for Brent to reach new records. North Sea crude grade could easily exceed the highs seen at the start of the Ukraine war. The result would be an acceleration of inflation and demand for decisive action from central banks. For now, they prefer to sit on their hands.

As Richmond Fed President Thomas Barkin noted, the Federal Reserve cannot fight higher energy prices with rate hikes — the supply shock is outside the central bank's control. Christine Lagarde and ECB Governing Council member Alessandro De Marco argue that medium?term inflation expectations in the eurozone are well anchored. De Marco believes futures markets have gone too far in their pricing. It is not certain that, after a tightening in June, the ECB will make many more moves down the road of monetary restriction.

Thus, the calm before the storm in the Middle East has stretched on. The White House has tried to find a way out, but it seems renewed military action may be unavoidable — and this time it could be even more destructive. Evidence of that is the attack by Iran-backed groups operating from Iraqi territory on the UAE oil infrastructure. Tehran has warned it could export the conflict beyond the region.

Tensions are rising, and next week, EUR/USD risks opening down on a gap. The US dollar will be bought as a safe-haven if US-Israeli missiles fly toward Tehran. Iran's response would not be long in coming.

Technically, on the daily chart, the bulls' failure to reclaim the pin bar signals weakness. The strategy of selling the currency pair on pullbacks remains valid and should not be abandoned. Short-term targets remain at 1.144 and 1.134.