Dollar Gains Face Higher Bar as Oil Prices Surge and Euro Faces Stagflation Dilemma

The recent escalation of the Middle East conflict has led to a surge in oil prices, causing a performance gap between commodity-linked currencies and those reliant on imported energy. The dollar's safe-haven appeal has yet to re-emerge, with the DXY index unable to break above its June high of 101.800.

The July FOMC policy meeting is the main event this week, but no change in rates is expected, and markets continue to price in close to two hikes by year-end. The bar for further dollar gains appears higher due to geopolitical risk and a hawkish Fed being less clear-cut drivers than usual.

The euro is under pressure as investors remain concerned about the eurozone's vulnerability to the conflict, which is pushing up energy costs and darkening growth prospects. A familiar stagflationary dilemma faces the currency: rising energy prices may justify a more hawkish ECB, but they also weaken the economic backdrop that the currency reflects.