Currencies: Oil-Driven Inflation

The dollar is navigating a particularly ambiguous environment, caught in a pincer movement between an oil-induced inflationary shock and the absence of a genuine flight to quality. Unlike typical periods of market stress, the greenback is not fully benefiting from its safe-haven status, suggesting that the markets are not yet pricing in a global recessionary scenario.

The primary support for the dollar currently remains crude oil. The rebound in energy prices is sustaining higher inflationary expectations, forcing the Federal Reserve to maintain a wait-and-see stance. Jerome Powell has made it clear: monetary policy is considered sufficiently restrictive to absorb the shock without an immediate reaction. In this context, expectations for rate cuts have been pushed back, while those for hikes have quickly evaporated, creating a generally favorable bias for the dollar.

However, this support remains fragile. The bond market is beginning to send more nuanced signals. After a period of tension linked to the oil shock, long-term rates are showing signs of stabilization, or even a pullback. Historically, this type of configuration reflects a gradual shift from inflationary risk towards the risk of an economic slowdown. In other words, the market is starting to consider that the energy shock could weigh on growth before becoming permanently anchored in inflation.

At the same time, economic fundamentals remain solid. American consumption is resisting, the labor market shows no major cracks and activity indicators remain expansionary. This resilience mechanically limits the demand for the dollar as a safe-haven asset and prevents a more pronounced appreciation.

The determining factor therefore remains external: the trajectory of the conflict and, above all, that of oil. As long as crude trades around or above $100, the dollar maintains a bullish bias through the channel of rates and monetary expectations. However, any credible de-escalation, accompanied by a lasting retreat in oil prices, could quickly reverse this dynamic by reactivating expectations of rate cuts.

In summary, the dollar is not yet on a clear directional path: it oscillates between two opposing forces: inflation versus growth. And as is often the case in this type of setup, a single variable will truly settle the debate: oil.

Technically, the Dollar Index remains within a narrow channel between 99.00 and 100.55, from which we still anticipate an upside breakout to finalize the rally underway since the beginning of the year at 101.10/57. This would translate into a final bearish wave for EUR/USD below 1.1665 towards 1.1315/1.1290,  before reversing to the upside.