EUR/USD was choppy into the weekend, oscillating between small gains and losses as markets waited for Tehran’s decision on a possible agreement with the US to end fighting in the Middle East. The pair was trading around 1.1573 at the time of writing and was set for modest weekly gains. Reports from Iranian Foreign Minister Abbas Araghchi and Pakistan’s Prime Minister Shehbaz Sharif pointed to progress towards an MoU, but uncertainty persisted over its terms, spanning frozen Iranian funds, Iran’s nuclear programme and the reopening of the Strait of Hormuz. With price action subdued, the US Dollar also traded in consolidation; the US Dollar Index (DXY) was around 99.75. Focus is shifting to next week’s Federal Reserve meeting under new Chair Kevin Warsh, with elevated oil prices complicating the inflation outlook as US CPI rose to 4.2% in May, compared with the Fed’s 2% target. In Europe, attention turns to May Eurozone inflation, where HICP is expected to hold at 3.2% year on year; the European Central Bank raised rates by 25 basis points on Thursday.

Opportunities in Volatility and Oil Markets

Given the tense wait for news on a US-Iran agreement, we see current low volatility in EUR/USD as an opportunity. A confirmed deal would be a major “risk-on” event, likely sending the Euro sharply higher against the dollar, while a collapse in talks could see a flight to safety benefiting the dollar. We believe buying options, like straddles, is a prudent way to position for a significant price swing in either direction. The reopening of the Strait of Hormuz is the most critical component, directly impacting oil prices, which are currently elevated near $95 per barrel for Brent crude. A peace agreement could quickly send prices tumbling back towards the $75-$80 range seen over the past couple of years, easing the inflationary pressures facing the Fed. We are therefore considering puts on crude oil futures as a direct play on the geopolitical outcome. Next week’s Fed meeting under new Chair Kevin Warsh presents a complex challenge. While a pause is expected, the persistent US inflation rate, which was last reported at 4.2% for May, will force him to maintain a hawkish tone. Any guidance that deviates from the market’s expectation of future rate hikes will introduce significant volatility into interest rate swaps and futures.

Directional Views on EUR/USD, Eurozone Inflation, and the Dollar Index

For EUR/USD specifically, the one-month implied volatility is sitting near 6.5%, a level that seems too low given the binary nature of the impending geopolitical news. We are positioning to capitalize on an expected rise in volatility, as the current subdued price at 1.1573 is unlikely to hold once a decision is announced. A confirmed deal could see the pair test the 1.1800 level last seen in early 2025. Across the Atlantic, the European Central Bank’s recent rate hike shows its own commitment to fighting inflation, with the Eurozone HICP stuck at 3.2%. An upside surprise in the upcoming inflation data would further bolster the Euro, providing a supportive floor for the currency. This reinforces our view that long Euro positions, perhaps through call option spreads, carry a favorable risk-reward profile. Finally, the US Dollar Index is sitting precariously below the key 100.00 mark at 99.75. A confirmed peace deal would almost certainly trigger a further wave of dollar weakness, potentially pushing the DXY towards the 2023 lows around 95.00. We are prepared to act on this by selling DXY futures or buying puts if the geopolitical situation de-escalates.

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