Middle East Tensions Overshadow G7 as Israel-Iran Conflict Escalates
Geopolitical risk has re-entered centre stage following a rapid deterioration in the Israel-Iran standoff, upending earlier hopes that the situation might de-escalate. Reports suggest President Trump departed early from the G7 summit in Alberta, Canada, after calling for a full evacuation of Tehran. This unexpected escalation quickly dominated summit discussions, overshadowing trade and economic issues and raising fresh concerns about G7 cohesion in addressing global crises.
The conflict has injected renewed volatility into global markets, particularly crude oil, which surged by as much as 12% on Friday. However, the traditional safe-haven response has been noticeably absent: the US dollar, rather than gaining, continued to weaken, underlining a significant shift in market dynamics.
Dollar Undermined Despite Oil Surge Amid Shifting Market Sentiment
The US dollar index (DXY) dropped to fresh 2025 lows yesterday, briefly touching 97.60 and struggling to maintain footing above the 98 mark. The juxtaposition of soaring oil prices—driven by escalating conflict in the Middle East—and a weakening dollar illustrates a growing divergence: markets are no longer treating the dollar as the primary safe haven it once was.
Historically, geopolitical turmoil and higher oil prices have bolstered the greenback. Now, however, sentiment surrounding the US economy appears to be a more dominant force. Persistent inflation concerns, political uncertainty, and fears of slowing domestic growth are acting as stronger headwinds than the oil rally is providing as a tailwind.
The Federal Reserve remains the dollar’s lone support. While recent softer CPI prints suggested room for easing, the Fed’s inflation vigilance has returned to the forefront. Rising tariffs and higher energy costs present fresh inflationary pressures, complicating the Trump administration’s desire for rate cuts. Import price data, due later today, will be closely scrutinised—particularly as it excludes tariffs. Any uptick would suggest that foreign exporters are not absorbing tariff costs, forcing US businesses to carry the burden.
Euro Resilient as Traditional Correlations Break Down
The euro has continued to defy conventional logic, gaining against the US dollar despite the Middle East conflict and a rally in oil prices—factors that would typically pressure the energy-dependent eurozone. EUR/USD has broken further into the $1.15 range, briefly eyeing the $1.16 handle.
Fresh hawkish commentary from ECB Vice President Luis de Guindos boosted sentiment, as he expressed confidence in the eurozone’s inflation trajectory. His remarks helped assuage fears of deflation and signalled that the ECB may be nearing its inflation target—reducing the likelihood of further rate cuts this year.
Markets appear to have interpreted the oil spike as a further reason for the ECB to maintain its tightening bias, reinforcing euro strength. Compounding the move, the dollar’s failure to respond to geopolitical stress left the euro as a relative beneficiary.
Later today, Germany’s ZEW sentiment survey is expected to show improvement—driven by optimism around forthcoming fiscal expansion, including the draft 2025 federal budget and the initial tranche of a €500 billion infrastructure fund. While not expected to drive dramatic euro gains on its own, a solid print could provide a welcome domestic boost.
Sterling Edges Higher but Lacks Clear Catalyst
Sterling recovered Friday’s losses, inching back towards the $1.36 mark against the US dollar. However, the pound remains in a delicate position—highly sensitive to broader risk sentiment, but less responsive to general dollar weakness than its G10 peers.
The start of the week saw sterling benefit from easing geopolitical jitters and falling oil prices, which boosted global risk appetite and helped the pound gain ground against traditional safe-haven currencies such as the yen and Swiss franc. That rally, however, was short-lived, with renewed volatility after President Trump’s abrupt Tehran announcement.
Domestically, expectations for Bank of England rate cuts continue to build, following another batch of disappointing UK data. Yet despite that, the pound is holding up relatively well. The $1.36 resistance level remains a key technical hurdle, but if EUR/USD breaks and sustains a move above $1.16, the resulting spillover could help push GBP/USD decisively higher.
In contrast, GBP/EUR has been drifting lower since the beginning of June, having broken below key technical support levels. A drop below €1.17 would open the door for further downside towards €1.16—unless eurozone momentum starts to fade.
