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Euro Forecast: Russia-Ukraine Tensions Create Downside Risks for EUR/USD

Euro Forecast: Russia-Ukraine Tensions Create Downside Risks for EUR/USD

Diego Colman, Contributing Strategist
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  • The EUR/USD has moved lower in recent days amid heightened risk aversion triggered by rising geopolitical tensions in Eastern Europe
  • If Russia decides to invade Ukraine, the euro could fall rapidly, but any weakness is likely to be transitory as the crisis could push energy prices higher, strengthening the case for faster monetary policy normalization amid soaring inflation
  • In this article, we explore the key technical levels to watch in EUR/USD over the next few days

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Most read: S&P 500, Nasdaq 100 Pressured as Ukraine/Russia Crisis Continues to Dominate Risk Assets

EUR/USD has been subdued in recent days, weighed down by rising geopolitical tensions and market turbulence across the globe. During times of uncertainty, investors flock to the safety of the U.S. dollar, shunning high beta currencies prone to wild swings.

Sentiment is unlikely to change materially in the coming trading sessions as frictions between Russia and the West continue to intensify. Investors fear that Moscow may stage a false flag operation and authorize the invasion of Ukraine in the next several days, a scenario that could spark risk aversion and boost safe-haven demand, at least temporarily.

Although recent developments in the Eurozone, such as the ECB’s hawkish pivot, have created a more supportive backdrop for the euro, the tense situation in Eastern Europe may limit bullish bets in favor of the common currency in the near term. Traders may also be reluctant to take large directional positions ahead of Monday's U.S. holiday (Washington's birthday), when lower liquidity could amplify volatility unexpectedly should negative headlines hit the wires.

In any case, it is important to note that if war breaks out in the region, EUR/USD could drop considerably, but weakness should be temporary, as the crisis may drive up energy prices, strengthening the case for faster monetary tightening. On that note, I’d be inclined to fade any sell-off caused by geopolitics.

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Overall, the euro has a slightly bearish to neutral bias for the week ahead against the dollar, but its medium-term outlook looks more constructive. Red-hot eurozone inflation, which reached 5.1% y/y in January, more than double the central bank's target of 2.00%, should prompt policymakers to accelerate the normalization process at their March meeting, paving the way for bond yields to reprice higher. This should benefit the euro, particularly if Fed officials opt to phase out accommodation gradually instead of front-loading rate increases, as one segment of the market anticipates.

From a technical perspective, EUR/USD began its descent after failing to clear resistance in the 1.1400/1.1390 area. If the pair continues to cruise lower, support is seen at 1.1280, this week’s low, but if bears manage to push price below this floor, selling momentum could intensify, setting the stage for a retest of the 1.1175 zone. On the flip side, if EUR/USD reverses higher and breaches the 1.1400/1.1390 barrier, buying interest could pick up pace, catapulting the exchange rate towards the 1.1500 psychological level.

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EUR/USD chart prepared in TradingView


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---Written by Diego Colman, Contributor

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.