Euro remains cautious as Middle East headlines, Fed outlook drive sentiment

The Euro (EUR) remains relatively cautious amid ongoing Middle East tensions and the Federal Reserve's (Fed) outlook, while the US Dollar (USD) continues to garner support. EUR/USD trades around 1.1453, having recovered from a low of 1.1433, its lowest since July 30, amidst a weakening Greenback and falling oil prices. The US Dollar Index (DXY) sits at around 100.40, following a peak earlier in the day.

Meanwhile, WTI Oil trades near $90, down over 5% this week. The UN General Assembly in New York, where US President Donald Trump and Iranian President Masoud Pezeshkian participate, garners market attention. US Secretary of State Marco Rubio stated that Washington is open to a meeting with Iran at the UN, though no meeting between Trump and Pezeshkian is currently scheduled.

Despite this, the USD may experience limited downside due to the Fed's potential for additional rate hikes. The ADP Employment Change four-week average increased to 20K from 16.75K, with the Fed raising rates by 25 basis points (bps) last week to 3.75%-4.00%. Sixteen of 18 officials expect at least one more increase this year. Susan Collins from the Boston Fed noted that inflation risks have heightened and the labor market appears stronger overall, suggesting a higher chance of inflation staying above the Fed's 2% target.

Brown Brothers Harriman strategists argue that while tightening by major central banks limits USD policy divergence from the Fed, the currency's underlying bias remains positive. A stronger US growth outlook relative to other economies also supports the USD being bullish. The Euro struggles to benefit from ECB rate hike expectations as oil prices remain high, negatively impacting the Eurozone growth outlook, given its heavy reliance on imported energy.

MUFG analysts state that Eurozone rate markets anticipate further tightening, with a 50:50 probability of another back-to-back hike in October. The ECB's primary mandate is to maintain price stability, targeting inflation around 2%, primarily through interest rate adjustments. Should inflation persist, the ECB could resort to Quantitative Easing (QE) to provide liquidity, which typically results in a weaker Euro. Conversely, Quantitative Tightening (QT) could bolster the Euro.