02.06.202600:43 Forex Analysis & Reviews: The Dollar is Tired of Geopolitics

Everything comes to an end eventually. Donald Trump is confident that it will all end well, with a deal between the US and Iran. However, mutual shelling ahead of the agreement is making investors nervous. The Americans struck enemy radar and command-and-control facilities. The enemy responded with an air raid on their base and attacks from Kuwait. Hostilities are ongoing, but neither Washington nor Tehran recognizes them as violations of the ceasefire. EUR/USD is learning not to believe its eyes, to trust words, and is oscillating back and forth.

Exchange rates in Forex depend on the monetary policy of central banks. This, in turn, responds to inflation, the labor market, and geopolitical shocks. Rising oil prices due to the conflict in the Middle East have lifted inflation expectations and consumer prices. This could prompt the Federal Reserve to tighten monetary policy. The futures market indicates a probability of about 50% that this will happen as early as 2026.

Dynamics of Treasury yields and the Fed rate

Markets often rise on expectations and, from time to time, do the central bank's work for it. The rally in Treasury yields indicates that financial conditions are currently moderately tight. In essence, a rise in the federal funds rate is not required to tame inflation.

A similar picture is present in the Eurozone, where the European Central Bank has reported a decrease in inflation expectations. Could the inflation spike really be temporary, as the White House and the governments of the currency bloc hope?

Dynamics of inflation expectations in the Eurozone

Investors are tired of the conflict in the Middle East. Stock indexes are rising as if it doesn't exist. However, the US dollar continues to react sensitively to news from the region due to its status as a safe-haven asset. In such conditions, the report on the US labor market for May will serve as a kind of breath of fresh air for traders.

The Fed has a dual mandate. It is forced to respond to both high prices and employment issues. By the end of 2025, these factors forced the central bank to ease monetary policy. But since then, the labor market situation has stabilized, and the Fed has shifted its focus to inflation. It could revert to its previous priorities if nonfarm payrolls compel it to do so.

For the ECB, a stagflation scenario could become problematic. Consumer prices in the Eurozone risk spiking above 3% soon. At the same time, the Bank of France's downward revision of GDP growth forecasts indicates an economic slowdown in the currency bloc. In such an environment, making decisions becomes extremely difficult.

Technically, on the daily chart, EUR/USD is returning to its fair value at 1.1645. A rebound could prompt buying, while a breakout could prompt sales of the euro against the US dollar. One option could be to stay out of a market that is not providing clear signals.