Investing.com — Geopolitical risks are building for Europe through the NATO channel, potentially capping support for the euro even as the European Central Bank turns more hawkish, Citi Research said.
Citi flagged several recent developments that it said were driving market price action more than interest-rate differentials alone. U.S. CIA Director Ratcliffe flew to Moscow in late August to warn Russian officials against escalating with NATO, particularly with the Baltic states, according to the Wall Street Journal and Politico. ‘
Citi noted that the last time a CIA director made such a trip to Moscow was in November 2021, to warn against an attack on Ukraine, according to the New York Times and the Council on Foreign Relations.
Russia has continued to escalate with NATO countries, Citi said, citing a drone attack at Leipzig’s airport in Germany, an incursion into Estonia that triggered NATO’s Article 4 and other reported incidents.
Citi said it was not suggesting Russia is preparing to invade a Baltic country, but that the potential remains for further “tests” of NATO countries, raising the risk of an event that could trigger another Article 4 or even Article 5 invocation, even unintentionally.
Separately, Citi said President Trump’s acknowledgment that Iran-related energy risk could persist through the midterm elections was the main driver of Friday’s move higher in energy prices, which then caused rates to sell off.
Iran has switched tactics to directly target U.S. Navy ships and bases with more advanced, harder-to-stop missiles, according to the Wall Street Journal.
Citi said the acknowledgment suggests limits to any relief trades from potential peace deal announcements.
On monetary policy, hawkish European Central Bank commentary also contributed to the day’s market moves, Citi said, pointing to President Lagarde’s comments dismissing 2.5% as the top of the neutral rate range and a statement that inflation will stay above target for an extended period.
Citi Economics shifted its ECB call to two 25-basis-point hikes, in December 2026 and March 2027, from a prior call of no more hikes.
Markets are already pricing more hawkishly, looking for back-to-back 25-basis-point hikes in October and December 2026, Citi said.
Citi said FX remains a relative trade, and the hawkish repricing was seen across G10 curves, not just for the ECB, limiting FX moves from rate differentials alone.
The euro traded slightly lower against the dollar despite a marginal move in EU-U.S. two-year yields in the euro’s favor, as the jump in energy prices hit Europe’s terms of trade, Citi said.
If FX continues trading on that basis, it could cap the euro’s upside against the dollar despite any divergence in ECB-Fed policy pricing, Citi said.