The Euro(EURUSD) could be particularly vulnerable to the long-term effects of the US-Israeli attack on Iran, as markets reposition to price in a global supply-side inflation shock. The EURUSD keeps trying to break lower as Eurozone assets fluctuate with crude oil prices. Unless the situation in the Middle East is resolved soon, The Euro(EURUSD) could be in for a significant slide.
Europe’s vulnerability to energy prices was made apparent with Russia’s invasion of Ukraine. The shared economy has made efforts to wean itself off Russian imports, making it vulnerable to other supply shocks. Already, amid tense talks over the war in Ukraine, Russia is threatening to shut off gas supplies to Europe, accounting for about 20% of the country’s gas needs. This comes after Qatar shut the largest LNG facility in the world due to the threat of Iranian missiles. It will likely take a month to restart the refining facility once the situation is deemed safe enough.
Higher Inflation Is Bad for the Economy
Saudi Arabia is still Europe’s largest supplier of crude. The Arab nation is shifting its export capabilities to its western coast in an effort to circumvent the closure of the Strait of Hormuz. But, on that side, Houthi rebels in Yemen have threatened to attack shipping. Major freight companies like Maersk have already started rerouting ships around Africa instead of risking the approach to the Suez Canal, increasing shipping times and costs for European consumers.
While the US has taken measures to try to ease the situation in the Strait of Hormuz, there hasn’t been a similar effort in the Red Sea, which is more directly affecting Europe. EU leaders are either reluctant or incapable of securing their most vital trade route during the crisis, as illustrated by the prior instance in which Yemeni rebels effectively closed the route, exposing Europe to trade complications in the last couple of years. Investors are now worried that the Eurozone’s sluggish economic growth will vanish, which could reduce demand for Euro-denominated assets.
Reversing the Trade Trend
Last year, The Euro(EURUSD) surged 17% amid a “sell America” trend as investors sold dollar-denominated assets and Europe picked up the lion’s share of traders worried about US policy uncertainty. However, if the Eurozone economy is at risk of shrinking, those flows could reverse, and with them the Euro’s gains.
The US is a net energy exporter with very little of its trade going through the Middle East, making it much less vulnerable to the consequences of a prolonged war with Iran. Since the war started, the dollar has appreciated by over 1%, while the Euro has also lost 1%.
What Are the Chances of a Rebound?
Europe has energy storage at a below average level, but enough to withstand short-term supply disruptions. But if shipping remains halted for more than a few weeks, it could have a growing negative impact on European assets.
US President Donald Trump said he wanted to resolve the situation within a month, but wars are notoriously unpredictable. The White House has announced measures to help restart shipping in the Strait of Hormuz, including offering naval escorts and insurance coverage, to start in the near future. Iran, for its part, says it has “total control” over the Strait and that it is open. However, multiple ships near the Strait have been attacked. Some analysts speculate that transit of the Strait won’t be practicable until the US degrades Iranian missile and drone capabilities significantly, and and its difficult to establish a timeline.
The EURUSD might hold the line in the short term as traders hope for a quick resolution in Iran. But, the longer it drags on, the more downward pressure be applied to The Euro(EURUSD).
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