29.06.202613:54 Forex Analysis & Reviews: EUR/USD extends gains as diplomatic progress eases dollar demand

High-profile geopolitical events over the past weekend did not bolster the dollar, despite the ambiguous situation. On the contrary, traders' initial reaction was negative for the US currency, and buyers of EUR/USD again tested the 1.14 figure.

Looking at the last two days, two interrelated storylines are key to assessing geopolitical risk in the FX market. First, the US-Iran negotiation track amid spikes in Middle East escalation. Second, the Israel-Lebanon negotiation process, which is complicated by Hezbollah's hardline stance.

The main development yesterday was that, after another round of reciprocal strikes, Washington and Tehran agreed to return to the negotiating table. Reuters reported that the parties agreed to suspend further escalation and resume diplomatic talks despite the extremely tense recent period. Al Arabiya said technical talks between the US and Iran will take place on Tuesday in Doha and will focus on the Strait of Hormuz crisis. That news is behind EUR/USD's optimistic tone today amid renewed risk asset appetite.

The second geopolitical development was even more surprising. Late last week, mediated by the United States, Israel and Lebanon reached a framework security agreement. Many analysts labelled it the most significant step forward in relations between the two countries in decades. The signed document envisages, among other things, a gradual reduction in tensions; an expansion of Lebanon's official army presence in the south; phased withdrawal of Israeli forces subject to security conditions; and, in the long term, the displacement of Hezbollah's armed influence.

On one hand, those events reduce the probability of broader escalation in the Middle East. That is why demand for the safe-haven dollar eased at the start of the week: investors focused not just on military action but also on the preservation of diplomatic channels and the prospect of continued negotiations. On the other hand, significant geopolitical risks clearly remain, and that fact prevents the formation of a durable uptrend in EUR/USD.

The logical question is whether longs on the pair are appropriate in the current environment. In my view, they are not.

As noted above, uncertainty persists in the Middle East, especially given Hezbollah's position. Almost immediately after the Israel-Lebanon agreement was signed, Hezbollah's leadership publicly rejected the deal. Representatives of the organization said they did not consider themselves bound by the arrangements, viewing them as concessions to Israel. That means Hezbollah maintains a course of armed resistance, increasing regional uncertainty.

In effect, the deal was struck between Israel and official Beirut, while the largest armed force in southern Lebanon remained outside the process. That point is crucial in the context of US-Iran relations, because Tehran has repeatedly signaled in recent weeks that the situation in Lebanon is part of broader negotiations with the United States. At the same time, Washington is attempting to reduce Iran's influence by weakening Hezbollah's position, Hezbollah being Iran's main ally in Lebanon.

Moreover, despite diplomatic progress, Israel continues to strike Hezbollah targets in southern Lebanon, citing the need to remove immediate threats. Full de-escalation is therefore premature. Weekend events reduced risk-off sentiment, but the diplomatic agreements remain fragile. Hezbollah's refusal to recognize the deal and ongoing local military actions show that the geopolitical factor can return to the fore at any moment if the diplomatic process breaks down. Similar uncertainty exists on the US-Iran negotiation track, whose next round will take place tomorrow in Qatar.

One more point is important. Last week (especially in its first half), the dollar enjoyed steady demand even without the geopolitical factor: hawkish Fed expectations helped the greenback. The market is gradually shifting toward a more hawkish scenario given the US economy's resilience and moderately hawkish signals from the regulator about its future actions.

This week that fundamental factor could strengthen. If key US macroeconomic indicators — the ISM manufacturing index, consumer confidence data, ADP, JOLTS, and NFP reports — print in the green, expectations of a longer period of unchanged rates (or even a hike in the second half) could firm significantly. In that case, the dollar may gain further support from classical fundamental drivers. That circumstance limits EUR/USD's upside potential despite the current easing of risk-off sentiment.

All of this suggests that long positions on the pair look risky. From a technical standpoint the pair on the daily chart remains between the middle and lower lines of the Bollinger Bands and is below all Ichimoku lines, which show a bearish "parade of lines" signal. However, on the four-hour chart, the pair is between the middle and upper Bollinger Bands. The priority, therefore, is short positions, but entering shorts is sensible only if bears push through support at 1.1380 (the H4 middle Bollinger line). The nearest main target for the decline is 1.1330, which corresponds to the daily lower Bollinger Band.