06.05.202600:59 Forex Analysis & Reviews: The Dollar is Not Looking for a Fight

The deadlock in US-Iran relations has forced Americans to seek a way out and launch the Freedom Project. However, attempts by tankers to pass through the Strait of Hormuz without Tehran's permission escalated the conflict. The Islamic Republic demonstrated who is in charge by attacking energy infrastructure in the UAE and shelling ships. Oil for December delivery surged to wartime highs, causing EUR/USD to decline.

The Polymarket interest rate market has lowered the probability of opening the Strait of Hormuz by the end of June to below 40%, down from around 70% three weeks ago. It is clear that the conflict in the Middle East is dragging on, and as Brent prices rise, the risk of a global recession increases. This is good news for the greenback. According to the Dollar Smile theory, the US currency strengthens in two cases: when things are going well and when everything is going poorly. A global economic downturn is the second scenario.

Dynamics of the Probability of Opening the Strait of Hormuz

Even if the main oil artery of the world is unblocked soon, oil prices are unlikely to return to pre-war levels by the end of 2026. This will cause more damage to countries and regions that import black gold, particularly the Eurozone and Japan. The US, as a net exporter of energy goods, will suffer much less. A strong economy equals a strong currency. This fundamental analysis principle has not changed. It clearly indicates the direction EUR/USD should move: south.

Regarding the European Central Bank's aggressive rhetoric about tightening monetary policy, it is more of a "hawkish" bluff than reality. The futures market anticipates 2-3 acts of monetary tightening; however, a stagflationary backdrop will compel the ECB to be cautious. At best, borrowing costs will rise by 25 basis points.

The rest will be a repeat of the 2008 mistake. Back then, Frankfurt raised rates out of fear of accelerating inflation, but then, amid the global economic crisis, it was forced to aggressively cut them.

The Fed's passivity and the ECB's slowness indicate that the interest rate and bond yield differentials between the US and Europe will remain wide. This will enhance the appeal of American assets relative to European ones and promote capital outflows into the United States. What better reason is there to sell EUR/USD?

The White House claims it is not seeking a fight, and the return to peace after a breach the day prior leads to a decline in oil prices. However, the deadlock is evident, with no clear exit paths. Sooner or later, bombs and shells will start exploding again. The better it is for the US dollar.

From a technical standpoint, on the daily chart, EUR/USD is testing the lower boundary of the fair-value range at 1.1675-1.1810. The first attempt failed; however, success for the bears on the second attempt will allow them to increase their previously formed short positions on the euro against the US dollar.