EUR/USD subdued & vulnerable beneath 1.1180After rising USD & Ukraine conflict halt reboundBucha allegations, sanctions & gas prices eyedAhead of ECB, Fed minutes, balance sheet plan

Image © European Central Bank

The Euro to Dollar rate further unwound its late March rally to open the new week but would potentially sustain a deeper setback if the international response to an alleged Russian atrocity in Ukraine leads to fresh volatility in energy markets over the coming days.

A stronger Dollar and uncertainty about the prospects for a peace agreement in Ukraine already had the Euro unwinding its late March gains ahead of the weekend, although the single currency remained on its back foot Monday and may be at risk of further declines over the coming days.

“Presumably, any moves from the EU toward a Russian oil embargo would see crude prices spike higher again and the euro come under pressure,” says Chris Turner, regional head of research for UK & CEE at ING.

“EUR/USD can probably consolidate in a 1.1000-1.1120 range over the coming days. For today look out for the Eurozone Sentix investor survey for April and later this week the eurozone highlight will probably be the release of ECB minutes on Thursday,” Turner and colleagues said in a Monday note.

This is all after the discovery of an alleged Russian massacre of civilians in the reclaimed town of Bucha, Ukraine, prompted international condemnation on Monday and drew calls from across Europe for further sanctions on Moscow.

Above: Euro to Dollar rate shown at daily intervals with Fibonacci retracements of late February decline indicating possible areas of technical resistance to any recovery, alongside selected moving-averages and spread - or gap - between 02-year German and U.S. government bond yields. Click image for closer inspection.

With Germany’s defence minister advocating on Sunday for a ban on Russian gas imports as a result of the allegations, growing public and political pressure for an energy embargo would be a potential risk to the Euro this week, given the Eurozone economy’s reliance on Russian gas.

So far governments of Germany, Austria and Bulgaria have resisted calls for a boycott or embargo, although if public or political pressure was to result in one being adopted it would be highly inflationary and likely damaging for the Eurozone economy.

“The war in Ukraine and its ramifications for risk appetite, energy prices, and inflation- and interest rate expectations are the reason we see short-term downside risk in EURUSD, which we believe could trade as low as 1.08 in the coming three months,” says Ingvild Borgen, an analyst at DNB Markets.

Significant increases in energy prices and risks of disrupted supply stemming from the war in Ukraine have weighed heavily on the Euro in recent weeks, more than offsetting the impact of a European Central Bank (ECB) monetary policy that is steadily becoming less of a burden for the Euro.

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“The ECB’s Schnabel stated that policy normalization is still appropriate, while the Fed’s Daly reportedly said that the case for a 50bp rate rise in May has grown,” says Peter McCallum, a rates strategist at Mizuho, in reference to weekend speeches from ECB and Fed officials.

ECB policymakers are increasingly suggesting that nothing can be ruled out for the bank’s monetary policy later this year due to recent continuing increases in Eurozone inflation rates and the risk of prices continuing to grow at too fast a pace over the coming years.

The ECB’s tolerance for further surprises will be top of mind for the market this week when minutes from the March policy meeting are released on Thursday, a meeting in which the Governing Council decided to wind down the Asset Purchase Programme sooner than was previously planned.

"Burgeoning recession risks look set to compromise any hawkish ECB assumptions. We remain wary of EUR drifting below 1.10 looking for 1.0965/75 ahead of strong support at 1.0945," says Jeremy Stretch, head of FX strategy at CIBC Capital Markets.

Above: Euro to Dollar rate shown at weekly intervals with Fibonacci retracements of 2017 rally indicating possible areas of technical support. Click image for closer inspection.

Anything in Thursday's minutes that appears to endorse market expectations for the ECB’s -0.5% deposit rate to be lifted back to zero percent by year-end could be supportive of the Euro, although before then the single currency must navigate the release of minutes from the March Fed meeting.

Wednesday’s Fed minutes are widely expected to contain details of the bank’s plan to shrink its $8.9 trillion balance sheet following the winding down of its quantitative easing programme, which bought $120BN government and mortgage bonds per month between March 2020 and March 2022.

“We continue to view the 1.08s as a place where the euro has a chance of bottoming or staging a larger bounce than most may anticipate. We do not see a bottom yet but remain on watch for one,” says Paul Ciana, chief technical strategist at BofA Global Research.

The Fed has been guiding investors to expect a full withdrawal of the interest rate cut from 1.75% announced in March 2020 and then some on top over the coming quarters due to recent sharp, and stubborn increases in U.S. inflation.

This has seen market pricing shift to imply a high probability of the Fed lifting its interest rate as far as 3% by late 2023, which has lifted U.S. bond yields relative to those in Europe and weighed heavily on the Euro.

The Fed’s pending effort to shrink its balance sheet will also lift U.S. bond yields further and could potentially burden the Euro this week if Wednesday’s plan for quantitative tightening points to a process that will be faster than financial markets have so far envisaged.

“Negative news on the war or a further lift in energy prices could see EUR/USD test 1.0800. However, an improvement in sentiment or a weak USD following the FOMC minutes could push EUR/USD through upside resistance around 1.1150,” says Joseph Capurso, head of international economics at Commonwealth Bank of Australia.