• EUR/USD weakens as renewed Middle East tensions boost US Dollar demand.
• Rising energy costs raise stagflation risks in the Eurozone.
• Traders increase Fed rate hike bets, with attention now on the upcoming NFP report.

The Euro (EUR) trades on the back foot against the US Dollar (USD) on Monday as reports of renewed attacks in the Middle East lift the Greenback.

At the time of writing, EUR/USD is trading around 1.1690, down about 0.25% on the day. Meanwhile, the US Dollar Index (DXY), which tracks the Greenback’s value against a basket of six major currencies, is trading around 98.28, extending Friday’s rebound from near two-week lows.

The United Arab Emirates came under attack from Iran for the first time since a fragile ceasefire in early April. A fire was reported at a petroleum site in Fujairah following a drone strike, while the British military said two cargo vessels were ablaze off the UAE coast.

Earlier in the day, Iran’s Fars news agency said two missiles struck a US naval vessel near the island of Jask after it allegedly ignored warnings from the Islamic Revolutionary Guard Corps (IRGC) to halt. However, a US official denied that any American vessel had been hit, according to Axios.

The renewed escalation comes as Tehran appears to be asserting control over the Strait of Hormuz, following US President Donald Trump’s announcement of a naval mission, dubbed “Project Freedom,” aimed at guiding stranded ships out of the waterway.

While diplomatic efforts to end the war are underway, the nuclear issue remains a key sticking point. Rising tensions in the Strait of Hormuz increase the risk of further escalation, keeping a geopolitical risk premium embedded in Oil prices.

The surge in energy costs has already pushed inflation higher across major economies, prompting central banks to maintain a hawkish stance. In the US, traders are pricing in a higher likelihood of rate hikes with the CME FedWatch Tool showing the probability of a rate hike at the December meeting rising to around 33% from near zero a week ago.

On the Euro side, markets are pricing in at least two rate hikes from the European Central Bank (ECB). However, the central bank faces a difficult trade-off given the Eurozone’s high exposure to energy shocks, which raises the risk of stagflation and limits the ECB’s room to respond aggressively.

Against this backdrop, EUR/USD upside remains capped unless a clear resolution to the conflict emerges and leads to a decline in Oil prices. Looking ahead, traders will keep a close eye on developments in the US-Iran situation, with attention also turning to upcoming US economic data, including Friday’s Nonfarm Payrolls (NFP) report, which could influence rate expectations.