EUR/USD, GBP/USD Forecast: Oil smoked as Iran deal hopes hit dollar

• Crude oil futures slide nearly 5% on Iran peace hopes
• EUR/USD, GBP/USD gap higher as dollar weakens
• DXY-Brent crude correlation jumps to 0.89 over past week
• Thin holiday liquidity raises risk of whippy price action

Oil slump drives fresh USD selling

Crude oil futures have been smoked on the open, sliding nearly 5% to the lowest level in a fortnight as traders continue to aggressively unwind geopolitical premium from energy markets.

Donald Trump helped kickstart the move on Saturday, saying a peace agreement between the United States and Iran had been “largely negotiated”, later describing any eventual deal as “good and proper” and “the exact opposite” of the Obama-era nuclear agreement.

EUR/USD and GBP/USD gapped higher on the news, with traders once again displaying the same asymmetric reaction function that’s dominated markets for months, jumping on any hints of de-escalation despite a stream of contradictory headlines casting doubt on whether a deal is imminent, or whether one materialises at all.

There will come a time when the secondary effects from the conflict come under far greater scrutiny, especially with questions lingering around supply chains, inflation and global growth. But that day is not today.

For now, the dominant macro trade remains the unwind in geopolitical premium, something that has become increasingly obvious when looking at the correlations driving the US dollar.

Oil and yields drive the dollar

Source: TradingView

Over the past week, the DXY has effectively traded as a crude oil proxy within the FX universe, with rolling correlations showing Brent crude holding the strongest positive relationship with the dollar index among major macro drivers at 0.89.

Front-end Treasury yields have also displayed an exceptionally strong positive relationship with the DXY over the same period, especially US two-year yields at 0.81, reinforcing the idea markets are increasingly treating oil as a proxy for near-term inflation risk and Fed pricing.

In other words, lower oil prices are helping to drag front-end yields lower, weighing on the dollar in the process while supporting major DXY counterparts such as the euro and pound.

What’s notable is how quickly these relationships have ramped up. The 20 and 60-day correlations between the DXY and Brent crude are nowhere near as strong, suggesting markets have become singularly focused on geopolitical headlines and what they may mean for inflation and Fed pricing.

EUR/USD nears major resistance zone

Source: TradingView

EUR/USD has broken out of the downtrend it had been trading in over the past week on the H4 timeframe, sending the pair back towards a resistance zone from 1.1660 through to 1.1682 that comprises several important levels, including the 200DMA and 38.2% Fibonacci retracement of the January-March bear move.

Should the pair manage to push above the top of the zone, which may prove difficult without concrete evidence a deal has actually been struck, 1.1700 and 1.1722 are the immediate levels overhead to watch.

On the downside, the breakout point from the former downtrend becomes the immediate focus below where the pair now trades, with dips beneath 1.1600 making for a decent zone to take profit on short positions and potential entry levels for longs.

The message from the oscillators is one where directional risks appear skewed to the upside on the H4 timeframe, with RSI (14) pushing higher above 50 while MACD is on the cusp of turning positive having already crossing above the signal line from below. A continuation of those trends would strengthen the appeal of playing the pair from the long rather than short side.

Sterling bulls force bullish breakout

Source: TradingView

GBP/USD has staged a bullish breakout from the ascending triangle structure it had been coiling within, sending the pair higher to test former support at 1.3485.

That’s the immediate focus overhead, with a sustained break bringing resistance at 1.3550 into play.

On the downside, 1.3450 may now flip to providing support, making it and the confluence of the 50 and 200-day moving averages just below the key zone to watch should the breakout falter. A reversal  beneath the 200DMA at 1.3424 may see bears target a retest of 1.3381 support and, beyond that, the May swing low of 1.3303.

Both RSI (14) and MACD are providing a mildly bullish message in terms of directional risks, with the former sitting at 64 and trending higher while the latter has flipped positive having already crossing above the signal line. Combined, it favours long setups over shorts in the near term.

With US and UK markets closed for public holidays, the liquidity vacuum likely to result increases the risk of whippy price action, ensuring risk management should remain at the forefront of traders’ minds before entry.