The euro is trading almost unchanged against the US dollar, near 1.1436, amid a prevailing sideways path since late June.
The euro faces the risk of escalation in the Middle East, including the expansion of targeting oil production and export infrastructure.
Meanwhile, the narrowing gap between US Treasury yields and their counterparts in the eurozone helps reduce the short-term impact of these risks on the euro.
We witnessed nine consecutive days of US strikes on Iran, which was met with the latter continuing to target maritime shipping in the Strait of Hormuz, as well as expanding its targeting of US bases, in addition to targeting power and water stations in Kuwait.
This naturally keeps shipping traffic very light through the strait, as only four ships crossed yesterday, according to LSEG data reported by Reuters.
Both sides have targeted energy infrastructure facilities, which is the last thing economies and markets want and what they fear most. This is because the inability of the current round of negotiations under fire to bring the two sides back to the negotiating table threatens to expand those targets, potentially hitting facilities responsible for oil production, export, and refining, as well as gas facilities in the region.
This comes at a time when we see no hope of reaching a comprehensive agreement in the near future with detailed wording on the core outstanding issues, namely the management of the Strait of Hormuz and the Iranian nuclear program. Without such detailed agreement, the risks of escalation and the resulting spillover of shocks into the eurozone remain.
The prolonged nature of the war involves risks of deepening structural damage that would make supply shortages chronic, keeping energy price inflation risks around for longer. These shocks could worsen as the escalation between Russia and Ukraine gradually points toward spiralling out of control, with Russian energy and refining facilities and oil tankers remaining high-value targets.
The sustainability of these escalation prospects is likely to exert continuous pressure on the euro against the US dollar, but the rise in eurozone bond yields at a faster pace than their US Treasury counterparts, and the narrowing of the yield gap, may limit the impact of the downward pressure on the euro for some time.
Since the beginning of this July, the yield on ten-year German government bonds has risen from 2.919 percent to 3.134 percent today, an increase of about 0.215 percentage points. In contrast, the yield on ten-year US Treasury bonds rose by only about 0.079 percentage points during the same period, to reach 4.558 percent. This puts the yield gap between US and German bonds at its lowest level since last May, near 1.43 percent. The situation is almost identical to the yield difference between Treasury bonds and their counterparts in the rest of the eurozone. This comes amid anticipation of another interest rate hike by the European Central Bank, bringing its total hikes this year to half a percentage point, while expectations still favour a single quarter-point hike by the Federal Reserve.
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