Fears that the new strain of the coronavirus "Omicron" could slow down the global economic recovery brought down global stock indexes on Friday and provoked a general flight from risk.
Against this background, the yield of 10-year US Treasury bonds fell by almost 10%, pulling the greenback, which sank by 0.75%, reaching a weekly low of 95.97.
The USD index declined sharply mainly due to the weakening of the dollar against the yen and the euro, whose share in the index is about 14% and 57%, respectively.
The fact that the yen, the main safe haven currency, has risen is not surprising. However, the question arises, why did the euro strengthen and the dollar weaken on the negative news about the coronavirus?
The fact is that the euro, like the yen, is a low-yielding currency. Due to the low interest rates of the European Central Bank, funds for carrying out carry-trade operations were used in it. Accordingly, avoiding risk caused the euro to be repurchased.
In addition, investors, apparently, felt that the last strengthening of the greenback had gone too far, and decided to lock in profits.
At the same time, the EUR/USD pair was oversold as much as it was last time in 2015. It is worth noting that often technical oversold becomes a reason for purchases.
On Friday, the EUR/USD bulls managed to push the pair to 1.1320, where it ended the last five days.
At the beginning of the new week, concerns about the new strain of the Omicron coronavirus subsided somewhat. Global stocks are trading in the green zone today, but it is still unclear whether this will turn out to be a fleeting fear or will deal a serious blow to the global economic recovery.
"Now we need to understand how severe the new strain is, and whether it will succumb to vaccines. Very little is known about him at the moment. Mutations are often less dangerous, so we should not rush to conclusions, but there are a lot of concerns," Deutsche Bank analysts note.
Meanwhile, vaccine manufacturers are testing the effectiveness of already developed drugs in the fight against the new COVID-19 strain, but the first results will appear no earlier than in two weeks. Pfizer and Moderna reported that it will take about 100 days to correct their vaccines, if necessary.
According to Citigroup analysts, it may take from two to eight weeks to clarify information about Omicron, during which the demand for riskier assets may suffer.
"At a low, volatility will be higher in the next two weeks," according to BCA Research Inc.
Markets remain in limbo, while the dollar benefits from uncertainty due to its safe haven status.
Greenback managed to regain his composure after Friday's sale.
On Monday, the US currency partially recovered losses after the strongest daily drop in a year, recorded at the end of last week.
Currently, the USD index is trading with an increase of more than 0.2%, around 96.30 points.
The dollar remains stable while investors are trying to understand whether the Fed will be forced to take a cautious stance on tightening policy in the face of a potential economic downturn.
According to the CME Group, the probability that the Fed will leave the key rate unchanged by June 2022 is 34.7% compared to 23.4% last Monday.
The focus of attention this week is monthly data on the American labor market.
According to forecasts, 550 thousand jobs were created in the United States in November, and the unemployment rate in the country fell to 4.5%.
A strong report on employment in the United States may emphasize the need for the Fed to accelerate the curtailment of monetary stimulus by $120 billion per month at the next meeting to be held in mid-December.
A new wave of the pandemic may cast doubt on these plans. Atlanta Fed President Rafael Bostic, however, downplayed the impact of the Omicron strain, saying that as soon as the consequences of a new outbreak become clear, the economy and the Fed will react accordingly.
He still expects one or two rounds of rate hikes in 2022, which will help contain inflation.
However, the final word always remains with the chairman of the Federal Reserve Jerome Powell.
Just nominated by the head of the White House Biden for a second term, Powell is due to speak at his speech about the CARES Law – the central bank's stimulus program for the pandemic period – at the Senate Banking Committee in Washington on Tuesday.
A similar hearing will be held in the House Finance Committee on Wednesday.
Investors are hoping to get fresh information about the prospects for the recovery of the American economy amid renewed uncertainty associated with the pandemic.
"Uncertainty about the omicron strain may weaken the purchase of the dollar against the background of expectations that the Fed may delay the normalization of monetary policy," ING analysts believe.
Meanwhile, The Goldman Sachs said it will not change its economic forecasts after the Omicron option appears until its likely impact becomes clearer.
The bank's strategists believe that the Fed will increase the volume of QE cuts to $30 billion per month from January next year. They predict that the central bank will raise the key rate in June, September and December 2022.
According to experts, the ECB will take the first step in this direction only in 2023. And until then, it will be easy to observe the record growth of consumer prices in the eurozone countries.
ECB President Christine Lagarde said on Friday that the ECB will act on interest rates when necessary and when price growth reaches 2% on a sustained basis, but she expects inflation to fall from January.
"At the moment it catches the eye and worries many people, but we do not expect this increase in inflation to last long," she said.
Amid a surge in inflation, the ECB is facing growing calls to tighten its monetary policy, and analysts do not rule out that the ECB will present investors with some "hawkish" surprises at the upcoming meeting in December.
However, at a time when Europe is struggling with another wave of coronavirus, the doves in the ECB Governing Council have new arguments to rebuff those who call for an early end to incentives.
On Monday, the EUR/USD pair lost its "bullish" momentum and rolled back below the 1.1300 mark.
The single currency cannot attract bulls amid the news that a new strain of the coronavirus "Omicron" has already been detected in several European countries. All this increases fears of new lockdowns and restrictions in Europe.
According to some estimates, a one-week quarantine will reduce the quarterly GDP growth of the eurozone by 0.2%-0.5%.
ECB Vice President Luis de Guindos believes that, despite concerns about the new COVID-19 strain, the impact of the virus on the economy will be less than in the past.
Lagarde has a similar opinion.
In response to the latest virus threat, she said that the eurozone is better prepared to withstand the economic consequences of the next wave of coronavirus or its new version of Omicron.
However, investors do not seem to share their point of view.
On Monday, the EUR/USD pair is under pressure, reversing the strongest daily gain of 2021, noted on Friday, as the dollar recovers along with US Treasury bond yields.
If the Fed maintains a hawkish attitude, and the ECB adheres to a dovish position, the difference in the monetary policy of central banks will continue to push the EUR/USD pair down in the coming months.
As for the technical picture, if Friday's peak is not broken in a fairly short time, bears may return to the market and force the pair to resume falling. Against this background, it is impossible to rule out a repeat visit to the lows of 2021 near 1.1185.
The probability of further losses will remain as long as EUR/USD is trading below the 2-month resistance line around 1.1570.
The nearest resistance is marked at 1.1320, then the bulls' target will be 1.1350 (the Fibonacci retracement level by 38.2% relative to the November decline) and 1.1380 (the 50-day moving average).