EUR/USD traded around 1.1390 in Asian hours on Wednesday, holding firm for a second day as the US Dollar weakened against the Euro ahead of the Federal Reserve policy decision, where rates are widely expected to remain unchanged. Pricing in derivatives implies a 30.5% chance of an immediate hike, and that is followed by a 76.6% implied probability of a rise in September, suggesting markets see borrowing costs staying higher for longer.
The Dollar’s downside was tempered by renewed Middle East hostilities, which refocused attention on inflation risks and the US rate outlook. Geopolitical tension rose after the IRGC launched a ballistic missile strike on a US base in Jordan at about 5:45 PM ET, while US Central Command said defences intercepted all missiles with no casualties or damage. CENTCOM then carried out precision airstrikes in Iraq against Iran-backed groups said to be planning operations targeting US forces and Saudi energy infrastructure. In Europe, the ECB unanimously held rates at 2.25% on July 23 and signalled a September hike, after some Governing Council members argued for an immediate increase given energy-price pass-through risks.
Volatility And Hedging Strategies For EUR/USD And Crude Oil
We recommend that derivative traders buy short-term EUR/USD straddles or strangles to profit from the massive pricing gap between the Fed and the ECB. With a 30.5% chance of an unexpected Fed rate hike today and a strong ECB September signal, implied volatility is currently trading too low. Historically, during similar periods of central bank divergence, EUR/USD one-month option implied volatility has jumped from average levels of 6.2% to well over 8.5%.
Given the escalating military actions in Iraq and Jordan, we should also hedge against a sudden spike in crude oil prices that could disrupt global supply chains. Brent crude call options are highly attractive right now, especially as defense intelligence highlights risks to Saudi energy infrastructure. In previous Middle East supply scares, such as the 2019 Abqaiq attacks, oil prices surged 15% in a single session, which would trigger a massive safe-haven flow into the US Dollar.
Directional FX Trades And Key EUR/USD Levels
For directional FX traders, we suggest establishing long-gamma positions to capture the sharp breakouts expected from the current 1.1390 level. The Euro’s strength is currently capped by these geopolitical risks, but a dovish hold by the Fed today could quickly push the pair toward the 1.1500 resistance level. Conversely, if the Fed surprises the market with a hike, we expect a rapid drop toward the 1.1200 support zone, making dual-sided barrier options an excellent risk-reward play.
