EUR\/USD was steady on Friday as markets reassessed the inflation effects of higher oil prices after Middle East tensions disrupted energy flows through the Strait of Hormuz. The pair traded around 1.1438 and was set to close the week with modest gains. Oil has risen about 12% this week, which has kept the prospect of tighter-for-longer policy in focus, even though June inflation in both the United States and the Eurozone came in softer than expected, tempering near-term rate-rise expectations.<\/p>\n\n
The ECB is expected to keep rates unchanged at 2.25% at next week\u2019s meeting after a 25-basis-point hike in June, while markets fully price a September increase. In the US, pricing for an imminent Fed move has eased, but markets still imply about a 75% probability of a hike by December, per the CME FedWatch Tool. The US Dollar Index (DXY) was flat near 100.76 after touching 100.35 on Wednesday. Separately, the University of Michigan\u2019s preliminary consumer sentiment index rose to 54.4 in July from 49.5, above the 51 forecast; one-year inflation expectations eased to 4.2% from 4.6%, while the five-year measure held at 3.3%.<\/p>\n\n
We advise derivative traders to hedge against further energy price shocks by purchasing out-of-the-money call options on Brent crude. With oil surging 12% this week due to tensions in the Strait of Hormuz, energy volatility is back, reminiscent of past supply shocks when Brent spiked toward $90. Buying protection now secures cheap upside exposure if supply disruptions in the Middle East worsen in the coming weeks.<\/p>\n\n
For the EUR\/USD pair, which is currently consolidating near 1.1438, we recommend using a long strangle option strategy to capture an impending volatility breakout. While the market is quiet today, the conflict between soft June inflation and rising energy costs will likely force a sharp move. Historically, similar periods of flat trading amid geopolitical tension resolve in a rapid 150-pip breakout once central bank meetings conclude.<\/p>\n\n
In the interest rate markets, we suggest buying September Euribor put options while remaining cautious on near-term Fed rate hikes. The ECB is expected to hold rates at 2.25% next week, but sticky energy prices make a September rate hike highly probable. On the other hand, the 75% market probability of a Fed hike by December looks too high now that one-year US inflation expectations have eased to 4.2%.<\/p>\n\n
Finally, we see an opportunity to buy put options on the US Dollar Index near its current 100.76 level. The greenback’s recent bounce from its three-week low of 100.35 is likely temporary, as the underlying economic data points to a stabilizing labor market rather than an aggressive tightening cycle. Historical trends show that when five-year inflation expectations remain anchored at 3.3%, the US dollar struggles to sustain gains without active rate hikes.<\/p>\n\n\n\n