Towards the end of last week, the USD bulls finally got lucky and managed to push the USD index above 96.00 points.
This was largely driven by fears of an escalating conflict around Ukraine, which intensified after reports of a deteriorating situation in Donbass, where the evacuation of civilians to Russia has begun.
Washington said it was only a prelude to a Russian invasion of a neighbouring country.
Moscow, on the other hand, once again denied any plans for an attack.
The escalation of geopolitical tensions in eastern Europe put pressure on key Wall Street indices and the EUR/USD pair, which ended negative for the second week in a row.
The S&P 500 fell more than 0.7% on Friday and shed 1.6% over the week.
At the same time, the euro depreciated against the US dollar by almost 0.3%, falling from a local high around 1.1375 to 1.1327. By the end of the week EUR/USD lost about 0.2%.
However, on Monday the greenback declined to 96.00 due to a slight improvement in risk attitude. In this backdrop, the euro headed towards $1.14.
"The price action reflects a combination of relief that Russia did not invade the Ukraine over the weekend (...) and the announcement that Presidents Biden and Putin have accepted in principle a French proposal for a diplomatic summit", a currency analyst at MUFG wrote.
French President Emmanuel Macron proposed to Russian President Vladimir Putin and White House President Joe Biden a bilateral summit on security and strategic stability in Europe the previous day. The two representatives agreed. This was announced by the Elysee Palace on Monday.
Many details of the proposed summit are unclear, however.
Macron's office and the White House have said that the content of the summit will be worked out by US Secretary of State Anthony Blinken and Russian Foreign Minister Sergei Lavrov during their meeting scheduled for February 24. Even that summit itself remains uncertain for the time being.
A spokesman for Joe Biden's administration said in an email that the summit was still "entirely tentative" as the timing and format had not yet been determined.
Hopes that the crisis may be moving towards de-escalation have helped improve market sentiment. However, investors realise that the overall situation looks too difficult to resolve soon.
On February 19, US Secretary of State Anthony Blinken said that Moscow's position in its response to Washington's proposals on security in Europe contradicted key US principles. In particular, he spoke about the need to end NATO's open door policy and return the alliance to its 1997 position.
On the same day, Russian ambassador to the US Anatoliy Antonov said that Washington's claims that Russia was responsible for the escalation of the situation around Ukraine were an attempt to put pressure on Moscow and devalue its proposals on security in Europe.
"The market is likely to keep chasing headlines without any clarity on the eventual outcome," analysts at Barclays cautioned in a note.
The US stock market will be closed on Monday due to the President's Day holiday.
Growing tensions between Moscow and the West over Ukraine are likely to continue to put pressure on equities, underpinning demand for safe haven assets.
The situation in Donbass remains volatile, and markets may be early to price in a diplomatic solution to the problem. Bearish risks to risky assets remain significant. This could provide some support for the US dollar and other safe havens this week, ING analysts said.
Given the very unstable situation in Donbass and the lack of assurance that diplomatic efforts can reduce tensions, we still see a high probability of risk assets falling in the short term. We believe that sanctuary currencies, which include the US dollar, could find some support this week, they said.
ING believes that the greenback could get some additional help from confirmation of expectations of a 50 basis point Fed rate hike in March, as the FOMC hawks will speak this week. Thus, in their view, the USD index could continue to hold above 95.50," ING believes.
This view will be supported by the coming macrostatistics for the United States which are expected to be strong. On Thursday the second estimate for US GDP growth in the fourth quarter of 2021 will be released with a forecast of 7% versus 6.9% in the first estimate.
Investors will also be keeping a close eye on Friday's data on the US Personal Consumption Expenditure Index.
According to forecasts, this favourite Fed inflation indicator rose by 6% year-on-year in January.
Fed officials have almost promised to abandon the pandemic zero-rate policy at their next meeting on March 15-16 to bring down inflation, which has surpassed the central bank's 2% target. However, it remains to be seen how aggressively they will respond.
Last week, St Louis Fed President James Bullard called for a full percentage point increase in rates over the next three meetings, a steeper path than the Fed has followed for decades.
Meanwhile, other officials have tried to outline a softer approach. For example, New York Fed Governor John Williams said on Friday that he did not see much need for the central bank to go big at the start of the rate hike cycle.
"With today's strong economy and inflation that is well above our 2% longer-run goal, it is time to start the process of steadily moving the [Fed's benchmark interest-rate] target range back to more normal levels," said J. Williams.
He estimates that US inflation will slow to around 3% by the end of this year.
J. Williams is considered a close ally of Fed Chairman Jerome Powell, who has not spoken recently, awaiting Senate confirmation of his candidacy for a second term as central bank governor.
J. Powell will present his next semi-annual report on monetary policy to the US House of Representatives Financial Services Committee on March 2. He will appear before the Senate Banking Committee on March 3.
For the time being, markets continue to revise their expectations regarding the trajectory of US interest rates.
At the moment the federal funds rate futures are pricing in 6.1 rate hikes of 0.25% each until the end of 2022, i.e. up to 1.75%.
Several Fed officials will speak during the week, including Tom Barkin, head of the Richmond Fed, Mary Daly, president of the San Francisco Fed, Loretta Mester, head of the Cleveland Fed and Christopher Waller, Fed governor.
In their speeches, traders will look for indications of the regulator's expectations on economic parameters, particularly inflation dynamics, and the Central Bank's monetary policy actions.
Continued uncertainty over the Fed's next steps keeps the greenback afloat and limits EUR/USD gains.
"A break above daily Ichimoku cloud at 1.1410 can lead to extension in bounce. 1.1260 and 1.1210, the 76.4% retracement of the rebound are short-term supports," Societe Generale strategists said.
Obviously, the single currency will need an additional catalyst to break through the $1.14 level.
This could be the ECB meeting on March 10. It could result in a change in the regulator's policy in favour of a stricter one.
However, there is still plenty of time before the ECB meeting and euro enthusiasts are being cautious.
Data released today showed that the eurozone's composite purchasing managers' index hit a five-month high in February.
According to Markit Economics, the eurozone composite PMI rose to 55.8 points this month from 52.3 points recorded in January, according to a preliminary estimate. Analysts had expected the indicator to rise only to 52.7 points.
Investors have largely ignored this data as the focus remains on geopolitical developments.
A significant easing of tensions in eastern Europe is still a long way off. However, there is a strong possibility that the situation will deteriorate further.
Therefore, there is reason to believe that traders will have another turbulent week ahead.