• War in the Middle East revived inflation-related concerns and is likely to force central banks to hike interest rates.
• European inflation ticked higher in February, market starts betting on ECB hikes.
• Dismal US employment data fueled risk-aversion and resulted in more US Dollar strength.
• EUR/USD is gaining bearish traction in the mid-term, with critical support at 1.1470.

The EUR/USD pair ends the week just below the 1.1600 mark, posting its largest weekly decline in over a year. Financial markets shifted to panic mode in March after United States (US) President Donald Trump joined forces with Israel and launched a massive attack on Iran on the last day of February.

War in the Middle East

Throughout the week, the Middle East crisis expanded and turned into an all-out war. Iran responded not only by targeting Israel, but also by hitting US military bases around the Persian Gulf, hitting both military and civilian objectives in neighbouring countries.

As an immediate consequence, Oil prices soared, with the barrel of West Texas Intermediate (WTI) crude surging roughly $20 and reaching levels not seen in almost two years. Demand for safety skyrocketed, and the US Dollar (USD) stands as the overall winner at the end of the week, posting its largest weekly gain in more than a year. On the contrary, the Euro (EUR) is among the worst performers.

But higher Oil prices and renewed USD strength are just the beginning. The long-lasting effects of the ongoing war in the Persian Gulf are enormous already even if, all of a sudden, the conflict ended today – something that won’t happen.

European inflation already heating up

Throughout the week, market participants learned that inflation in the Old Continent unexpectedly rose in February. Indeed, the fact that the preliminary estimate of the EU Harmonized Index of Consumer Prices (HICP) reached 1.9% YoY instead of the expected 1.7% does not seem worrisome at first sight. Neither the fact that the Producer Price Index (PPI) rose 0.7% on a monthly basis after declining by 0.3% in January. At the end of the day, both remain below the European Central Bank (ECB) goal of 2%. Not to mention, a revision of the Q4 Gross Domestic Product (GDP) showed annual growth at 1.2%, down from the previous estimate of 1.4%.

off the table Not only has inflation in the EU approached the ECB’s goal, but with the ongoing Middle East conflict, it is likely to largely surpass it in the upcoming months. A 20% spike in energy prices is no joke. Europe relies on energy imports, and while the Union has planned ahead ever since the Russia-Ukraine war and has full storage ahead of the winter, EU demand will likely add to higher energy prices. Market players are already betting on rate hikes coming before the year’s end. No more “good place” for President Christine Lagarde & co.

And what about US inflation and the Federal Reserve?

Higher inflation is not just an European problem. The US recently reported that the Personal Consumption Expenditures (PCE) Price Index, the Federal Reserve (Fed) favorite inflation gauge, hit 3% YoY. Additionally, the US labor market deteriorated sharply in February, according to the latest Nonfarm Payrolls (NFP) report.

The country lost 92K job positions in February,, a significant swing to the worse compared with the 126K jobs gained in January. Even further, the Unemployment Rate surged to 4.4% vs the 4.3% expected. Finally, annual wage inflation, as measured by the change in the Average Hourly Earnings, rose to 3.8% from 3.7%. The dismal report contributed to the already very dismal market mood, resulting in higher highs for the USD.

In this scenario, cutting interest rates as US President Trump desires is off the table. Speculative interest trimmed bets on three rate cuts this year.

Other than that, President Donald Trump indicated that there will be no deal with Iran except unconditional surrender, while suggesting he will be involved in electing the next Iranian leader.

What’s next

War-related headlines are likely to keep investors on their toes. Risk aversion won’t recede as there is no end in sight for the Middle East conflict, which continues to intensify.

Concerns may grow in the upcoming days, as both Germany and the US are expected to release inflation updates. The US February Consumer Price Index (CPI) is scheduled for Wednesday, previously at 2.4% YoY.

More relevantly, the US will publish the February PCE Price Index on Friday. If core inflation ticks above the previously reported 3.0%, markets will start betting on rate hikes in the US, an impossible scenario for the upcoming Fed Chair, Kevin Harsh. Still, bets on higher interest rates are expected to further fuel the USD rally.