The conflict in the Middle East is driving up energy prices and reshaping the foreign exchange market landscape. The euro's decline this quarter is expected to be its worst since the start of 2024, once again exposing Europe's high dependence on energy imports and casting a shadow over the region's economic outlook. Options market data shows that demand for downside protection on the euro hit a four-year high this month, with bearish sentiment rising to recent peaks.
The euro has already fallen about 2% against the US dollar this quarter, currently trading near $1.15, with a cumulative drop of 2.5% in March alone, marking the largest single-month decline since July 2024. This stands in stark contrast to the euro's strength in late January when it broke above $1.20 and touched a near five-year high. Morgan Stanley strategist David Adams and his team expect the euro could further test $1.13 in the short term.
Rising oil prices and potential blockages in the Strait of Hormuz have led currency traders to revisit the trading logic of the 2022 Russia-Ukraine war—at that time, European markets were hit hard and the dollar strengthened significantly. Meanwhile, money markets have fully priced in three interest rate hikes by the ECB this year, a remarkable shift compared to just weeks ago when a 35% probability of a rate cut was still being priced in.
<img src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/9cfd05ac-da95-4f98-b250-8396b3e0b127.png?x-oss-process=image/auto-orient,1/interlace,1/resize,w_1440,h_1440/quality,q_95/format,jpg" alt="Image" original-src="https://imageproxy.pbkrs.com/https://wpimg-wscn.awtmt.com/9cfd05ac-da95-4f98-b250-8396b3e0b127.png"/>
<h2>Options Market Shows Rising Bearish Sentiment</h2>
Signals from the derivatives market are more pessimistic than analyst forecasts. A Bloomberg survey shows analysts targeting $1.20 for the euro by year-end, but the path implied by options contracts is much weaker. Earlier this month, market demand for downside protection on the euro hit a four-year high; the previous preference for paying high premiums on bullish bets has completely vanished, with market sentiment turning neutral.
Looking at specific currency pairs, bearish options bets on EUR/JPY are outnumbering bullish ones by nearly four to one; positions against the CHF and AUD are also leaning bearish, though to a lesser extent. However, the euro is not weak across all pairs—according to DTCC data this month, traders' willingness to bet on EUR/GBP rising is more than four times that of betting on a decline, and Eurocurrency Market sentiment shows significant divergence across different currency pairs.
<h2>Energy Shock Places ECB in a Dilemma</h2>
Surging oil prices are pushing the European Central Bank into a difficult policy predicament. ING noted that while rate hikes typically support a currency during economic strength, the supply constraints triggered by the Middle East situation break this logic—a reduction in overseas investment by Gulf countries during the crisis will tighten global financial conditions, and growth-sensitive currencies like the euro will be the first to suffer.
German inflation data shows the inflation rate climbing to its highest level in a year, driven by energy prices. The ECB faces a situation identical to 2022: energy-driven inflation and a slowdown in economic activity are occurring simultaneously, leaving extremely limited policy space.
<h2>Fiscal Optimism Fades, Growth Forecasts Downgraded</h2>
The fiscal tailwinds that previously supported the euro are fading. Optimism regarding Germany's fiscal policy shift and defense spending expansion has cooled significantly, while the OECD has concurrently downgraded its Eurozone growth forecast. Germany and Italy are also considering lowering their official growth projections.
This means that the multiple tailwinds that propelled the euro to a near five-year high at the start of the year—fiscal expansion expectations and the weakening dollar narrative—have been negated one by one by the energy shock within just a few weeks.

Recent escalation in Middle East conflicts has heightened market concerns over geopolitical risks. At the same time, international oil prices are fluctuating with the situation, impacting the global energy market and overall risk sentiment. Sectors such as energy, shipping, and technology could all face direct impacts.How long do you think the Middle East situation will affect the Hong Kong and U.S. stock markets? Is it a short-term fluctuation or a long-term impact? Feel free to share your thoughts!

Recent escalation in Middle East conflicts has heightened market concerns over geopolitical risks. At the same time, international oil prices are fluctuating with the situation, impacting the global energy market and overall risk sentiment. Sectors such as energy, shipping, and technology could all face direct impacts.How long do you think the Middle East situation will affect the Hong Kong and U.S. stock markets? Is it a short-term fluctuation or a long-term impact? Feel free to share your thoughts!

Escalating tensions in the Middle East—will oil price volatility stir the stock market?

L5EW

Driven by rising energy prices due to the conflict in the Middle East, the euro's decline against the US dollar this quarter is expected to be its worst since the start of 2024, falling 2.5% in March. Options markets show that demand for downside protection on the euro has hit a four-year high, as bearish sentiment intensifies. The energy shock coincides with a slowdown in economic activity, and the fiscal tailwinds that drove the euro's strength at the beginning of the year have been offset one by one

- Rising energy prices due to Middle Eastern conflicts are reshaping the foreign exchange market, causing the euro to experience significant declines.  
- The euro has fallen about 2% this quarter, with a notable drop of 2.5% in March, while options markets show a peak in demand for downside protection.  
- The European Central Bank faces policy challenges as surging energy prices impact inflation and growth forecasts, with markets adjusting expectations on fiscal support and economic outlook for the eurozone.

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Middle East Conflict Hits European Economy Hard! Euro Records Worst Quarterly Performance Since the Start of 2024, Bearish Sentiment Climbs to Four-Year High