The Achilles' heel of energy has been accurately targeted! The euro has become the most wounded currency in the Iran conflict.

Columnist and former Haitong London Chief Market Strategist Marcus Ashworth recently wrote that since the outbreak of the Iran conflict, global markets have seen a massive deleveraging wave of risk assets, with the eurozone exchange rate and interest rate markets being particularly hard hit. Against the backdrop of widespread safe-haven buying in the US dollar pushing up the dollar index, the euro has seen a larger decline against the US dollar than all other major currencies, with the decline being twice that of the pound; at the same time, market expectations for the European Central Bank's monetary policy have undergone an extreme reversal, shifting from pricing no policy action for the whole year to quickly betting on an interest rate hike as early as July this year. Ashworth warned that ECB policymakers need to be extra cautious and blindly following market expectations for rate hikes could further exacerbate the eurozone's woes. Just a few weeks ago, the euro against the US dollar had touched the 1.20 level, a level that had always raised alarms for the ECB; but this week, the euro against the US dollar exchange rate has suddenly dropped to around 1.15, this sharp short-term drop can easily trigger unease at the central bank level. With the European economy highly exposed to rising energy prices, as oil prices hover around $100 per barrel, Europe is facing a deadly threat of rising energy prices: the painful memory of soaring energy costs after the outbreak of the Russia-Ukraine conflict in 2022, remains vivid in the market's memory. This situation has forced ECB policymakers to seek a balance between controlling inflation expectations and the current economic weakness. The market has already started betting on a rate hike by the central bank just a few days ago there were expectations of a minor rate cut, but now the focus has shifted to policy tightening by mid-year. Ashworth believes that if left to ferment, these expectations could lead the central bank astray. Bundesbank President Joachim Nagel recently stated that the ECB remains "highly vigilant" about inflation risks, and emphasized that the March 19 Governing Council meeting "will determine whether action is needed." However, in Ashworth's view, this statement is not helpful, and President Lagarde should come forward to calm the turbulent markets. Ashworth clearly doubts whether the eurozone economy can withstand a rate hike, let alone consecutive hikes tightening policy could ultimately backfire on the euro. "The ECB previously expected economic growth of 1.2% this year, based on improvements in domestic consumption, rising household incomes, and a better financing environment. But the oil price shock is clearly at odds with this outlook." Ashworth said, "The current inflation situation is mixed: consumer prices rose by 1% in February year-on-year, only half of the ECB's target; but core inflation unexpectedly rose from 2.2% to 2.4%, highlighting the eurozone's high sensitivity to external price pressures." Ashworth said that if it weren't for such a drastic repricing of rate expectations in the market, the euro would probably have fallen even harder. But the deeper issue is that the euro has not yet become the safe-haven currency that policymakers desperately want it to be. Analysts at France's Industrial Bank mentioned in a report, "Despite both U.S. Treasuries and stocks falling, investors are still willing to hold dollars in the current environment, especially relative to the euro." As prices of commodities priced in dollars continue to rise, there is further exacerbation of the market's demand for the dollar. George Saravelos, Global Head of FX Research at Deutsche Bank, pointed out in a report on Tuesday: "The negative supply shocks currently unfolding are akin to the direct tax Europeans must pay to foreign producers in dollars." He estimated that for every 10% increase in Brent crude oil prices, the euro against the dollar exchange rate would drop by about 0.8%. Signals in the cross-currency swap markets are also worth watching: compared to other major currencies globally, the market's demand for the dollar has surged, reflecting a significant increase in financing demand for dollar liquidity abroad. Currently, the basis swap spread for the euro against the dollar has reached its highest level since April 2nd, following the "Liberation Day" tariff shock, and the pound and Swiss franc basis spreads are showing similar trends. Ashworth pointed out that the pressure on dollar financing is not yet significant at the moment, but rising bond yields and market reluctance to take on duration risks are subtly reminiscent of the energy crisis in the 1970s. Therefore, although there is no panic yet, the risk premium is rising. From a geopolitical perspective, Europe is closer to conflict regions, so local investors naturally have a higher sensitivity to risk avoidance. If the conflict escalates, the eurozone will face greater upward pressure on inflation and downward pressure on the economy than other economies; whereas the situation for American assets will be quite the opposite even if the conflict is quickly resolved, American assets are likely to receive a greater upward boost. It is worth noting that in the rebound in global markets this month, the rebound strength during US stock trading hours has been significantly stronger. For major central banks, moderate exchange rate fluctuations are within the norm for dealing with, but severe one-sided adjustment of exchange rates can often push them out of their policy comfort zone. Ashworth warned that direct intervention in the foreign exchange market can easily lead to unexpected consequences, and verbal statements regarding potential interventions are usually meaningless the experience of the Swiss National Bank is a typical example, as it attempted to verbally lower the Swiss franc exchange rate last week, but the market has widely speculated that the SNB has indeed intervened to stem the rise of the Swiss franc to its highest level since 2015. In the long run, the lack of domestic energy supply capacity has always been a major problem for the European economy, which means it can only passively accept global energy prices without any bargaining power. Under stringent net-zero emission requirements, the European manufacturing industry already faces huge operational pressures, and exchange rate fluctuations will only further increase the difficulty of long-term planning for businesses, while the increasing expectations of rate hikes will have a more severe impact on the real economy. "In the current situation where there is no sign of easing in the Russia-Ukraine conflict, Europe urgently needs the Iran conflict to be quickly resolved," Ashworth said, "the weakening euro may be the most obvious manifestation of market pressure, but it also exposes longer-term structural problems. Allowing market expectations of rate hikes to continue rising will fundamentally not solve the current core issue."