The initial market reaction to the war in Ukraine was significant. Elevated volatility, with a flight to safety and commodity prices soaring. As the weeks roll on, these moves are gradually unwinding and this is impacting across major forex. However, the US dollar (USD) is one currency that is well-positioned to stand tall throughout.

  • With the US position of relative economic strength and the Fed tightening, a stronger USD looks likely
  • Selling pressure on the Euro (EUR) is beginning to ease
  • Commodity currencies reversing lower as commodity prices retreat

USD strengthening is favored

Charting the performance of major currencies versus the USD in the past month, we see European forex (EUR and GBP most specifically) underperforming, whilst the commodity currencies (mostly AUD and NZD) have been significantly outperforming.

However, these performances (versus USD) are all beginning to fall across this chart. Moves below 0% would suggest a negative performance versus USD. The past week has seen JPY, CHF and GBP all weakening in addition to the AUD and NZD also beginning to turn lower.

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We see that the USD is well-positioned to perform well as market participants continue to come to terms with the Russian war with Ukraine. That is because the US is best positioned of all the economies to weather the economic storm. Here is why:

  • It is a net energy exporter with very little exposure to Russia (Europe and Japan are most at risk, with the UK also struggling)
  • The Federal Reserve is likely to increase interest rates significantly this year (potentially by +1.25% or +1.50%.

We are going to get a fresh set of economic projections from the Fed at the FOMC meeting on Wednesday. The ECB recently cut GDP forecasts for 2022 by -0.5% so it will be interesting to see the sort of hit that the Fed is expecting this year. It is likely to be much less.

For this reason, we believe the Fed will be far more interested in controlling inflation which could reach 8.5% to 9% on the CPI in the next few months. Decisive monetary policy tightening will follow, and this will benefit the USD.

EUR is rebounding near term

We are seeing EUR higher today. This is coming on better news surrounding the negotiations between Russian and Ukrainian delegates in the search for a diplomatic resolution. However, we believe that the path to peace will be at best rocky, and may not be seen at all.

Subsequently, there will be elevated volatility to EUR performance. The more stable strength of the USD looks to be a better performing currency. Looking at EUR/USD the breakdown below 1.1120 was a key move that opened downside towards 1.07/1.08 and we believe that recoveries are likely to be sold into for further pressure on the recent low at 1.0805 and potentially below.

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Commodity currencies about to reverse

The USD has not been the outstanding performer amongst major currencies of the past month. The Aussie (AUD) and Kiwi (NZD) have been strong throughout. The Reserve Bank of New Zealand is already tightening rates, and it may not be long until the Reserve Bank of Australia (potentially Q3). However, it has been the sharp rise in commodity prices that has been a key factor in driving outperformance.

However, as commodity prices have started to retreat, the AUD and NZD have also started to falter versus the USD in recent days. AUD/USD has retreated into a key band of support around 0.7245/0.7275. A close under 0.7245 would be a negative signal, so this looks to be an important moment. Momentum is also reflecting this with the RSI around 50. A decisive close under 0.7245 would also complete a small top pattern and imply -120 pips towards 0.7125.

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A recovery in EUR/AUD is threatening 

Perhaps given the uncertainty of EUR/USD direction, there is a better opportunity in a recovery EUR/AUD. A couple of weeks ago we discussed the negative outlook on EUR/AUD. The selling pressure has stabilized in recent days. The pair is also close to forming a recovery. If the reversal of these market trends that we are seeing this morning continues (European assets recovering, commodity prices lower) then we expect EUR/AUD to recover. 

After such a big sell-off throughout February, there is plenty of scope for an unwinding rally. A close above 1.5160 would complete a bull flag pattern and imply a recovery towards 1.5500. Already we are seeing the RSI leading the market higher. The overhead supply of Q4 2021 trading is between 1.5350/1.5560. The near-term support at 1.4910 is key, being potentially a higher low.

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