Fed and ECB Policy Decisions Loom, but Oil Drives Markets | Investing.com

• US dollar eases as equities stabilise, but oil and war risks keep sentiment fragile.
• Markets price potential conflict easing while Hormuz disruption keeps uncertainty elevated
• EUR/USD stuck in consolidation as Fed and ECB decisions drive near-term direction

We have seen the ease back down a bit as equities have found some mild support in the last couple of days. A bit of risk is coming back to the market as have stalled. It is clear that some investors are trying to price in the potential end of the Iran conflict and are buying the dip in equities.

Whether or not that’s the right thing to do while the Strait of Hormuz remains effectively shut for the Gulf States as the war continues, remains to be seen. Others are sitting on their hands and awaiting clarity. That indecisiveness has left the FX markets in a bit of consolidation mode, raising questions about the near-term direction, especially heading into this week’s key central bank meetings.

Crude Oil Remains the Driving Force

With both the and the European Central Bank set to announce policy decisions, traders appear to be taking a cautious stance for now. However, the balance of risks may be tilting slightly in favour of the US dollar in the short term – especially if oil prices find renewed momentum.

Interestingly, the relationship between oil prices and the dollar has been somewhat distorted since tensions escalated. Rising energy prices, often supportive for the dollar due to their inflationary implications, have not translated into the same strength this time around. That may simply reflect traders pricing in the end of the conflict, while some are shifting their focus towards central bank policy signals.

So, this may also be due to position-squaring ahead of the FOMC meeting, rather than a decisive shift in sentiment towards risk. Indeed, markets remain highly sensitive to tensions in the Middle East, and in particular regarding the Strait of Hormuz, which has a huge impact on global energy supplies.

Dollar Steady Ahead of the Fed Decision

Anyway, the Fed is widely expected to keep interest rates unchanged tonight, and that shouldn’t come as a shock. However, the real focus will be on the updated Dot Plot, which offers insight into policymakers’ interest-rate projections. At present, the median projection points to one rate cut by the end of the year.

There is a meaningful chance that policymakers will revise this path higher, but whether the market will take that seriously is another question. If the Dot Plot suggests no cuts, then the dollar could receive a short-term lift. But policymakers can and will change their views as the situation in the Middle East evolves and oil prices adjust accordingly.

It is also quite possible – and likely even – that markets may not receive particularly detailed guidance from Jerome Powell on the inflation implications of geopolitical tensions. The situation in energy markets remains fluid, and policymakers may prefer to avoid strong forward guidance while uncertainty around oil prices persists.

How Will the Euro Respond to ECB Policy Decision?

So, the immediate focus will be on the Fed and if the FOMC’s Dot Plot leans hawkish, the EUR USD exchange rate could come under renewed pressure – at least momentarily. While the pair has shown reduced sensitivity to short-term rate differentials in recent months, a firmer dollar narrative following the Fed meeting could easily trigger at least a short term drop in the pair.

Attention will quickly shift to the European Central Bank meeting taking place on Thursday when we will also hear from multiple other CBs. While the ECB operates under a primarily inflation-focused mandate, the broader economic outlook often plays a significant role in its policy messaging. And that’s where the oil-price shock will come into play.

Already, we have seen eurozone sentiment data – the ZEW survey – falling to their lowest level in almost a year. Clearly, this is reflecting rising concerns about the economic fallout from geopolitical tensions and higher energy costs. That backdrop could encourage policymakers to strike a slightly more cautious tone.

If the ECB signals concern about the growth outlook or emphasises the temporary nature of energy-driven inflation pressures, it may push back against the more aggressive tightening expectations that have built up in recent weeks. That’s what I am expecting anyway. Still, the implications for the euro may be limited.

Short-Term EUR/USD Levels to Watch

The EUR/USD remains in a bit of a quagmire at the moment. On the one hand, it has found solid support around last summer’s lows, just above the 1.14 handle. This week, it has also managed to climb back above the previously broken 1.15 level—both of which are mildly positive signals.

On the other, the broader trend still points to weakness as lower highs remain in place, and the EUR/USD has broken below the 21-day exponential moving average, which has also crossed below the 200-day moving average in another bearish development.

With the 1.1560 resistance level still firmly intact, it can be argued that the path of least resistance continues to be to the downside. That said, for renewed selling pressure to build, the pair likely needs to break back below the 1.15 handle to trigger another leg lower. This makes this psychological level particularly important.

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Disclaimer: This article is written for informational purposes only; it does not constitute a solicitation, offer, advice, counsel or recommendation to invest as such it is not intended to incentivize the purchase of assets in any way. I would like to remind you that any type of asset, is evaluated from multiple perspectives and is highly risky and therefore, any investment decision and the associated risk remains with the investor.

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