EUR/USD is swinging between modest gains and losses ahead of the weekend as investors await Tehran’s decision on a possible deal with the United States (US) to end the war in the Middle East. At the time of writing, the pair is trading around 1.1573 and is on track to post modest weekly gains.
Iran’s Foreign Minister Abbas Araghchi said the memorandum of understanding with the United States “has never been closer.” Pakistan Prime Minister Shehbaz Sharif also said that the final agreed text of the peace agreement had been reached and that Islamabad was working closely with both sides to finalize the next steps.
However, uncertainty persists amid conflicting reports on the content of the MOU, including the release of frozen Iranian funds, the future of Iran’s nuclear program and the reopening of the Strait of Hormuz.
As a result, investors are taking a wait-and-see approach, maintaining moderate price action while the US dollar (USD) also consolidates. The US Dollar Index (DXY), which tracks the dollar’s value against a basket of six major currencies, is around 99.75.
In addition to geopolitical events, attention is currently focused on next week’s meeting of the Federal Reserve (Fed), under the leadership of newly appointed Chairman Kevin Warsh. Warsh takes over at a hard time, as elevated oil prices hamper the progress of disinflation. U.S. CPI accelerated to 4.2% in May, more than double the Fed’s 2% target.
While the pause will be fully taken into account at next week’s meeting, the focus will be on the Fed’s future guidance and whether policymakers’ outlook lines up with market expectations for interest rate increases later this year.
Investors across the Atlantic are also awaiting inflation data in the euro zone for May. The Harmonized Index of Consumer Prices (HICP) is expected to remain unchanged at 3.2% y/y, after accelerating above the European Central Bank’s (ECB) target of 2% in recent months.
On Thursday, the ECB raised interest rates by 25 basis points in response to rising price pressure. Any upward surprise in May’s inflation data would reinforce expectations that the central bank will need to maintain a tight monetary policy stance for an extended period of time.
Fed FAQs
Monetary policy in the US is shaped by the Federal Reserve (Fed). The Fed has two missions: achieving price stability and promoting full employment. The basic tool for achieving these goals is adjusting interest rates. When prices rise too swift and inflation exceeds the Fed’s 2% target, it raises interest rates, increasing borrowing costs throughout the economy. This results in a stronger US dollar (USD) because it makes the United States a more attractive place for international investors to park their money. When inflation falls below 2% or the unemployment rate becomes too high, the Fed may lower interest rates to encourage borrowing, which will negatively impact the dollar.
The Federal Reserve (Fed) holds eight policy meetings a year, during which the Federal Open Market Committee (FOMC) assesses economic conditions and makes monetary policy decisions. Twelve Fed officials attend the FOMC meeting – seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four of the remaining eleven regional reserve bank presidents, who serve one-year terms on a rotating basis.
In extreme situations, the Federal Reserve may apply a policy called quantitative easing (QE). QE is the process by which the Fed significantly increases the flow of credit in the gridlocked financial system. This is an unusual policy measure used during crises or when inflation is extremely low. This was the Fed’s weapon of choice during the Great Financial Crisis in 2008. It involves the Fed printing more dollars and using them to buy high-quality bonds from financial institutions. QE tends to weaken the US dollar.
Quantitative Tightening (QT) is the reverse process of QE, in which the Federal Reserve stops purchasing bonds from financial institutions and does not reinvest capital from the bonds it holds at maturity to purchase recent bonds. This is usually positive for the value of the US dollar.
