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The past week turned out to be successful for risky assets. The key Wall Street indices marked the highest rise since November 2020, increasing by an average of more than 6%. The EUR/USD pair jumped by almost 1.3%, showing the largest weekly gain since the beginning of February.
The improvement of risk sentiment and the weakening of the position of the protective greenback occurred for a number of reasons.
1) Light at the end of the tunnel
Apparently, market participants began to play out the stabilization of the situation in Ukraine in advance, acting on the principle of "buy on rumors, sell on facts."
Investors have become entrenched in the idea that Moscow and Kiev will eventually reach some kind of agreement. Any ceasefire – even temporary - would be a positive moment for the single currency, as the conflict unfolds in close proximity to the borders of the eurozone. It would also negatively affect the dollar, the safest of havens.
2) China gives new hope
The world's second-largest economy has gone from being a potential obstacle to global growth to moving forward. The Chinese authorities have promised to support the national economy and stock markets. The choice in favor of new incentives is welcome both at home and abroad.
3) A breath of fresh air from the Fed
Federal Reserve Chairman Jerome Powell managed to reassure investors by saying that the US economy is strong enough to cope with the tightening of monetary policy.
At its next meeting, the FOMC raised the key rate from almost zero to 0.25-0.5% per annum. The central bank intends to limit itself to nine steps of raising rates in the next two years. This is certainly softer than many traders have expected in recent months.
Relieved that the long-awaited Fed news has finally come out, the US stock market has returned to the levels it was at before the entry of Russian troops into the territory of Ukraine.
On Friday, the main Wall Street indexes closed higher. At the same time, the S&P 500 increased by 1.17% to 4,463.12 points.
The fact that the negotiations between the American and Chinese leaders – Joe Biden and Xi Jinping – on the Ukrainian crisis ended without big surprises contributed to the preservation of optimistic market sentiment. Both sides stressed the need for a diplomatic settlement of the crisis.
"Instead of having fears and concerns about what the Fed might do, we now have a clear monetary policy roadmap. As for Russia and Ukraine, the market was more positive about the news from the diplomatic front than it was negative about the escalation," National Securities Corporation analysts said.
After the US stock market rose for three consecutive days last week, many investors began to hope that the worst was behind them.
JPMorgan analysts predict that the S&P 500 will end the year at 4,900 points, which is about 10% higher than the closing level of Friday trading.
"The market seems to have coped with the Fed's long-awaited rate hike, and its monetary policy is likely to be as hawkish as possible," they said.
Meanwhile, strategists at Goldman Sachs believe that investors underestimate the risks associated with the Russian-Ukrainian conflict.
"The rise in US stock indices, as well as the slowdown in oil prices after a sharp jump, indicate a decrease in the degree of tension in traders' assessment of the global consequences of the conflict. This means that the markets are now more exposed to risks associated with a possible termination of negotiations or with a further reduction in energy supplies to the world market," they noted.
Some market optimism related to the possibility of de-escalation of the Russian-Ukrainian conflict seems unjustified, analysts at MUFG Bank say.
"Although there is information that the parties are making progress in negotiations, the ongoing military actions on the ground suggest the opposite. Investors will again move away from risks, and this will support the dollar," they believe.
"There is an opinion that the US currency is usually sold off in the first six months of the Fed tightening cycle, since players in this case tend to act on the principle of "buy rumors, sell facts." What distinguishes the situation this time, in our opinion, is the decisive tightening that the Federal Reserve is going to undertake, and the events in Ukraine that have damaged the prospects for economic growth in Europe and will put pressure on the currencies of the region," ING analysts said.
"The softening of the momentum of European currencies against the US dollar will limit the growth potential of the EUR/USD pair. We note opportunities for a pullback to the level of 1.0900," they added.
At the beginning of the new week, the main currency pair is trading in a narrow range, changing within 40 points.
At the same time, the key US stock indexes do not show clear dynamics.
The demand for risk has decreased, but there are no pronounced sales either. In the absence of significant statistics on both sides of the Atlantic, players are swinging after the weekend and are deciding on further steps with an eye on the situation around Ukraine.
Over the weekend, the Turkish Foreign Minister said that Moscow and Kiev are close to an agreement on key issues, and expressed hope for an early ceasefire.
However, the positions of the parties are still far from reaching a full-fledged compromise. Based on the current situation, there is reason to believe that the deadline for the end of the conflict is likely to be shifted to the second half of April.
The EUR/USD pair is slowly saying goodbye to the 1.1100 level again. The prospects of a protracted crisis in Ukraine will weaken the euro, according to Commerzbank.
"The longer the crisis continues, the more likely it is that the real economic and inflationary consequences - primarily for the eurozone – will be significant. And that is why such a prospect is negative for EUR/USD," they said.
The main currency pair cannot gain a foothold north of 1.1100. This suggests that the pair's rebound may have ended, OCBC economists believe.
"The short-term positive momentum is still maintained, but a quick reversal before the resistance of 1.1150 may mean that the peak of the rebound has appeared. There is a potential for a downward reversal at the end of this week if the pair does not consolidate above 1.1100," they noted.
The comments made today by European Central Bank President Christine Lagarde helped to soften the euro's drawdown, but also did not provide it with significant support.
The head of the ECB said that she does not see the risks of stagflation.
"Even in the darkest scenario – with unexpected consequences, an oil and gas embargo, and the deterioration of the military situation for a long time – even in such a scenario, we expect economic growth of 2.3%," Lagarde said.
At the same time, she stressed that any tightening of monetary policy in the eurozone will not be as fast as in America, due to differences in the macroeconomic situation in the eurozone and the United States.
"We live in different universes, we are at different phases of the cycle, with different starting points. We have negative rates in the eurozone, whereas in the US rates have never fallen below zero," Lagarde said.
Markets are putting in quotes the possibility of two increases in the ECB's key rate before the end of the year, while the Fed has already implemented the first increase last week, and by the end of the year, the leadership of the US central bank expects six more hikes.
As for the technical picture, the 1.1090-1.1100 area now acts as an immediate strong resistance before the 1.1135-1.1140 area, followed by the 50% Fibonacci retracement level of the recent fall. A decisive breakthrough of this level will open the way to additional growth. Next, the pair may aim for the round mark of 1.1200 and try to overcome the next significant obstacle in the area of 1.1230 (the Fibonacci correction level by 61.8%).
On the other hand, the 1.1035 area is now the nearest support, the breakdown of which will send the pair back below the psychologically important 1.1000 mark to retest the Fibonacci retracement level by 23.6% around 1.0970. Subsequent short positions will bring 1.0900 into play before the pair eventually falls to 1.0860 on the way to the current year lows recorded earlier this month near 1.0800.
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