EUR/USD vulnerable, could retest 1.09Energy prices & Ukraine talks in focusU.S. PCE data & Fed likely headwindsEZ CPI could help support EUR/USD

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The Euro to Dollar exchange rate recovery from early March lows stalled last week, leading the single currency to partially reverse some of its gains ahead of the weekend and leaving it at risk of a deeper setback over the coming days.

Europe’s single currency slipped back beneath the 1.10 handle against the Dollar ahead of the weekend after a last minute uptick in oil and gas prices appeared to weigh on the Euro just as the greenback found itself on a firmer footing against many major currencies.

The Euro-Dollar rate has proven vulnerable to sharp rallies in energy prices, which could be seen again this week if the Kremlin pushes ahead with an effort to force “unfriendly countries” into paying for Russian gas in roubles rather than Euros and Dollars.

“That sent gas prices sharply higher after an extended downtrend and weighed on global risk sentiment,” says Chris Turner, global head of markets and regional head of research for UK & CEE at ING.

Above: Euro Dollar rate shown at 4-hour intervals with Fibonacci retracements of March rebound indicating possible areas of short-term technical support. Click image for closer inspection.

“The combination of lingering Russia-related risks, high energy prices and Fed-ECB policy divergence still points to a weaker, rather than stronger, EUR/USD,” Turner said on Friday when tipping the Euro for a “drop to 1.0800-1.0900 in the coming weeks.”

The Kremlin’s plan places European countries between a rock and a hard place because if implemented it would undermine the impact of international sanctions imposed on Moscow over its war in Ukraine, while a refusal to pay in Roubles could potentially compromise European gas supply.

The latter would be an upside risk for energy prices and almost surefire weight around the ankles of the Euro to Dollar rate, although both of these will also be sensitive to the outcome of this week’s negotiations between Russia and Ukraine, which are potentially an upside risk for the Euro.

Talks resume in Turkey on Monday before continuing through Wednesday and any further suggestions of progress toward a ceasefire or resolution of the conflict would likely be supportive of Euro exchange rates almost across the board, and vice versa.

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“While there is continued talk of progress in peace talks between Russia and Ukraine, there has been no clear breakthrough” cautions Derek Halpenny, head of research, global markets EMEA and international securities at MUFG, who tips EUR/USD for a fall toward 1.07 in the weeks ahead.

“It makes us wary that market participants are pricing in an overly optimistic outcome. All of this is unfolding against a backdrop of an aggressively hawkish Fed that is fuelling a sharp flattening of the 2s10s curve, which tends to be supportive for the dollar,” Halpenny said in a Friday research note.

While positive noises from the Russia-Ukraine negotiations would likely be positive for the single currency, the Euro-Dollar rate will also have to contend with a Federal Reserve (Fed) interest rate outlook that continues to pose upside risks for the greenback.

This is after Chairman Jerome Powell told the National Association for Business Economics Conference last Tuesday that interest rates could potentially be lifted in increments of 0.50% on more than one occasion, and at a faster pace than financial markets have so far envisaged for the coming months.

Above: Euro-Dollar rate at weekly intervals with Fibonacci retracements of 2017 recovery indicating likely areas of medium-term technical support. Click image for closer inspection.

The risk of a faster moving Federal Reserve could grow as a burden on the Euro this week if Thursday’s reading of the Core PCE Price Index for February, which is the Fed’s preferred barometer of inflation, shows domestically-generated inflation gaining further momentum again last month.

“After a string of monthly gains of 0.5%, the core PCE deflator—the Fed’s preferred inflation gauge—may have posted a slightly more moderate 0.4% (0.373% unrounded) increase in February,” says Kevin Cummins, chief U.S. economist at Natwest Markets.

“A realization of our forecasts would push up the year/year rate from 5.2% in January to 5.5%—marking the strongest y/y gain since April 1983. However, the February reading may also mark the peak in the core PCE deflator,” Cummins said last week.

With energy prices and the U.S. PCE report aside, the highlight of the week for the Euro is March inflation data due from Eurostat on Friday, which is widely expected to reveal new records for the main inflation rate as well as for the core measure that overlooks changes in energy and food costs.

These kinds of numbers would potentially be supportive of the Euro-Dollar rate if financial markets view them as making the European Central Bank (ECB) more likely to take further steps along the path toward monetary policy normalisation later this year.