EUR/USD hit a one-year low on Tuesday as investors rotated into the safety of the U.S. dollar, while bearish technicals imply the pair could weaken further. Even so, traders holding short EUR/USD positions may need to closely watch U.S. inflation markets, which are hinting that the Federal Reserve may not need to stay as hawkish as is currently expected.

Both U.S. 2-year and 5-year inflation breakeven rates rose from December through early May, but have since reversed lower. They are now trading below the levels seen before the Iran conflict and have fallen back to territory last seen in January. U.S. 2-year and 5-year inflation-linked swaps have followed a similar path, also moving back toward pre-conflict levels.

A key driver has been oil . As the U.S. and Iran move toward a peace deal, oil prices fell sharply from April highs and could decline further. If that happens, market-based inflation measures may face additional downside pressure.

That makes upcoming U.S. PCE, CPI, and PPI releases especially important. If those reports show inflation is not as strong as currently feared, the dollar and U.S. rates markets could retreat sharply if they lead investors to reduce expectations for Fed rate hikes . If market-based inflation gauges are right, EUR/USD short positions could be vulnerable to a sharp squeeze higher.
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(Christopher Romano is a Reuters market analyst. The views expressed are his own)