The euro/dollar pair retested the 1.15 area again today after yesterday's corrective pullback to 1.1655. As expected, EUR/USD buyers were unable to hold their positions against a broadly firmer US dollar. The US Dollar Index is once again pressing the 99 area as geopolitical risks intensify. The Middle East conflict continues to worsen and, it would appear, may be more protracted than initially assumed. Bleak leaks from influential US outlets are fanning the flames and maintaining market anxiety.
Politico reports, for example, that the Middle East war could last until autumn. According to the outlet's sources, CENTCOM has asked the Pentagon for additional intelligence personnel to support the military operation for at least 100 days. Journalists reasonably infer from that request that the operation may run far longer than the four-week window first mentioned by Donald Trump. The report also suggests the White House did not fully anticipate the large-scale consequences of the war it launched.
Meanwhile, the escalation continues to pick up pace, and the conflict's geography is widening. Yesterday a US submarine sank an Iranian frigate in the Indian Ocean off Sri Lanka—the first time a US submarine has sunk an enemy ship since World War II. Israel has begun a ground operation in southern Lebanon while also conducting massive air strikes on Beirut.
Iran is responding with strikes on Israel, on US military bases, and on regional oil infrastructure. Tehran has also carried out targeted drone strikes on some tankers (two ships have been reported hit so far). Iranian authorities have threatened to blow up the nuclear reactor in Dimona if Israel attempts to change the regime in Iran.
In short, the Middle East conflict is not abating; it is intensifying. Given recent events, the Politico report on a protracted war looks plausible—especially since none of the parties (the US, Israel, or Iran) appear ready to pursue diplomacy publicly. Top politicians continue to issue belligerent statements that point to a continuation of hostilities.
The beneficiary of the situation is the safe-haven dollar, and not only because of a rise in risk aversion. A sharp rise in energy prices is feeding inflationary expectations, weakening hopes for dovish Fed policy. While earlier in the year markets had considered a rate cut at the March Fed meeting possible, the prospect of cuts in June now looks very uncertain. According to the CME FedWatch Tool, markets are now almost 100% certain the Fed will keep policy unchanged at the spring meetings. The probability that the pause will persist into June is about 70%. Two weeks ago, traders were pricing instead a 70% chance of a rate cut.
In other words, the dollar has hit something of a jackpot, benefiting from persistent demand as a defensive asset amid fading dovish expectations. In addition, US ISM prints published this week have been in the green zone, providing extra support for the greenback.
The ISM manufacturing index remained in expansion in February at 52.4, effectively unchanged from January's 52.6. At the same time, the prices subindex jumped to 70.5, the highest reading since June 2022, signaling a sharp increase in inflationary pressure alongside the acceleration in the PPI (headline and core).
Yesterday's ISM services report completed the picture. The ISM services activity index also moved into expansion, rising to 56.1 in February, its highest reading since July 2022, while most analysts had expected a modest decline to about 53.5.
Almost all subindices printed in the green: the business activity indicator rose to 59.9 (from 57.4), new orders to 58.6 (signaling further expansion of the headline index), employment to 51.8 (an unexpected move into expansion), and export orders to 57.2 (an explosive rise from 45.0). The prices subindex stood at 63.0, above the 60-point threshold. Together with rising oil prices, this mix creates the risk of a second wave of inflation in the US.
All of this indicates the services sector—which accounts for about 70% of the US economy—is accelerating rapidly. If tomorrow's Nonfarm Payrolls beat expectations as well, the dollar is likely to hit the jackpot again, gaining broad market support.
Accordingly, the current fundamental backdrop for EUR/USD does not favor a price reversal, as corrective upticks should still be treated as opportunities to open short positions. Targets remain unchanged: 1.1600 and 1.1550 (the lower line of the Bollinger Bands on the H4 chart).