FX.co ★ EUR/USD: US dollar rising, while zero rates keep euro down

The US dollar is pushing new highs, while the euro is experiencing one of its worst slumps in 9 months.

The end of Russia's war against Ukraine could launch a relief rally, helping the euro recover.

In this scenario, EUR/USD could jump by 200 pips.

Currently, the situation in Eastern Europe is deteriorating. As a result, investors see no reason to open EUR/USD long positions. The pair lost 1.84% over the week.

Escalating geopolitical tensions boost the US dollar, which is considered to be a safe haven asset, against the European currency. Furthermore, the imminent hawkish policy shift by the Fed is giving support to USD. The European Central Bank continues to follow its dovish monetary policy. The ECB's QE program is still in place.

The war between Russia and Ukraine is less likely to affect the US economy compared to the EU economy, The Federal Reserve's policymakers have some room for maneuver, unlike their counterparts in the ECB. Inflation in the US is above 7% - the highest level in 40 years, while unemployment has fallen to the lowest level since 1970, according to recent data.

"Our monetary policy has been adapting to the evolving economic environment, and it will continue to do so. We have phased out our net asset purchases. With inflation well above 2 percent and a strong labor market, we expect it will be appropriate to raise the target range for the federal funds rate at our meeting later this month," Fed chairman Jerome Powell told the Committee on Financial Services of the US Congress on Wednesday.

Powell also noted that ending the pandemic-era monetary stimulus would include raising the Fed funds rate and reducing the regulator's balance sheet.

During his speech before the Senate Banking Committee, the Federal Reserve's chairman reiterated that he would support raising the interest rate by 25 basis points at the next FOMC meeting.

Powell pointed out that the war between Russia and Ukraine has not affected the regulator's plans to increase interest rates and bring inflation back to the target level of 2%.

"I do think it's going to be appropriate for us to proceed along the lines we had in mind before the Ukraine invasion happened," Jerome Powell said. He added that the regulator would hike the rate higher at the following FOMC meetings, if inflation did not decrease.

Senators focused on the current situation facing the Federal Reserve. Furthermore, they pointed out that the Russian invasion of Ukraine could push up inflation and weigh down on US economic growth.

Powell told the committee that great uncertainty existed for both supply and demand. However, the healthy financial positions of households and businesses would help maintain spending, he added.

The chairman also said that the Federal Reserve is monitoring the situation and modelling the impact of soaring oil prices on the economy.

Oil prices have jumped from $75 per barrel in late December 2021 to $110 per barrel last Thursday. According to rough estimates by Powell, if commodity prices continue to rise, it would add 0.9 percentage points to inflation and reduce economic growth by almost 0.5 percentage points.

"We're going to see upward pressure on inflation at least for a while," Jerome Powell said when speaking about rising commodity and energy prices. He added it was unclear how long the upward pressure would continue.

The US dollar found support in Powell's statements about possible hawkish policy measures by the Fed. USD gained more than 0.3% against other major currencies.

USD has also ignored weak macroeconomic statistics which was published early this week.

Services ISM declined to 56.5 points, down from 59.9 points in January and well below the projected increase to 61.0 points.

EUR/USD fell by 0.5% and closed near 1.1065 yesterday under pressure from rising USD and hawkish statements by Jerome Powell.

The pair remains under pressure on Friday. USDX is trading above 98.00 – the highest level since March 2020.

According to Societe Generale, the index would rise towards the next targets at 98.35-98.80, if the uptrend continued. USDX's short term support levels are the November high at 96.95 and the trend line at 95.90.

Political news and US labor market data are the main focus of traders this week.

Yesterday's negotiations between Russia and Ukraine and talks of a possible ceasefire only briefly gave optimism to market players.

While both sides agreed on holding a third round of negotiations as soon as possible, the situation remains tense.

USD could remain strong if non-farm payrolls do not disappoint the markets. Earlier projections suggested the US economy added 400,000 new jobs compared to 467,000 in January.

According to DBS Research, the war between Russia and Ukraine forces investors to seek safe haven assets, such as the US dollar. The impact of war and sanctions against Russia are detrimental to the euro.

EUR/USD broke through the key level of 1.1060 and continued to slide down on Friday.

According to ING analysts, it likely would not take long before EUR/USD breaks below 1.1000. However, strong NFP data, additional Western sanctions against Russia or further energy price spikes could contribute to the breakout.

ING analysts expect Russia's war against Ukraine to pose more risks to the EU than the US. Rising natural gas and electricity prices could weigh down on recovery of the manufacturing sector and consumer spending, slowing down the normalization of monetary policy in Europe. There are no hints that ECB could raise interest rates at its meeting next week.

Bloomberg reported that ECB could halt winding down its monetary stimulus program. The situation in Ukraine causes uncertainty in economic outlooks.

Earlier, ECB's Phillip Lane said the central bank was closely following the economic impact of the war and would do all necessary measures to support economic recovery in the region.

The Fed is expected to stick to its original plan, preparing to hike interest rates for the first time since the beginning of the pandemic. The ECB, on the other hand, is forced to be cautious, which benefits the dollar and puts pressure on the euro.

Economists at OCBC Bank reported that the pair has touched lows and could test support at 1.1000. "Even if the pair does not breach 1.1000 on the weekly close, expect the level to stay under pressure next week," the outlook said. A breakout below 1.1000 would open the way towards 1.0850-1.0800.