Military operations are always force-majeure for financial markets. Investors want to hope for the best, but previous forecasts become irrelevant when such events develop. Let’s discuss it and make a new trading plan for EURUSD.
Weekly fundamental forecast for US dollar
Trade wars troubled financial markets in 2018-2019, and the pandemic — in 2020-2021. The year 2022 is a year of geopolitics. Optimists find comfort in hoping that geopolitics-related developments increase volatility and are not a real trigger for stock indexes. Still, the Nasdaq Composite says the opposite, flirting with bears for the first time since March 2020. The index is teetering, retracing by 20% from November’s maximums, Brent soared above $100 a barrel, and the EURUSD collapsed to the bottom of figure 12.
Vladimir Putin announced a beginning of a special military operation in Donets Basin. Its scale is unknown. He stated that Russia does not plan to occupy Ukraine but asked Ukrainian soldiers to “lay down arms and return home.” Kyiv declared a state of emergency, started mobilization, and called on the West to introduce new sanctions against the aggressor. A risk appetite is falling rapidly as investors understand the situation will likely worsen.
The war in Ukraine might undermine the market’s optimism concerning a post-pandemic economic recovery. Europe will have the toughest after-effects as it imports 50% of its gas and oil from Russia. An energetic crisis will hit its GDP hard. The ECB estimates that a 10% gas shortage might cut the eurozone’s economy by 0.7%. Increasing electricity bills will be more painful for the Europeans than Americans, which suggests a divergence between the US and the eurozone’s economic growth paces and gives a reason for selling the EURUSD. JP Morgan downgraded its forecast for European GDP in Q1 from 1.5% to 1% but still expects that the eurozone’s economy will get back to pre-pandemic growth levels.
Growing prices for energy resources contribute to inflation growth to its record highs and intensify the ECB’s headaches. Christine Lagarde and her colleagues should think twice about what to do with monetary stimuli that, on the one hand, push consumer prices further and, on the other hand, support GDP.
The war in Ukraine will certainly impact the US inflation, whose long-term nature forces the derivatives market into raising the probability of a 50-basis point rise in March to 41%. Together with the USD’s status as a safe-haven currency, that will drive the EURUSD down to 1.12.
Weekly trading plan for EURUSD
My previous recommendation to buy the euro was based on two assumptions: there will be no war in Ukraine, and the Fed will not raise rates 6 or 7 times in 2022. As those assumptions are questioned now, I have to revise my forecast for the major currency pair. The EURUSD is less likely to pull back from the area of 1.117-1.121. On the contrary, a breakout of support at 1.121 and 1.117 might make the pair continue to drop to 1.112 and 1.105.