Kambiz Kazemi, Chief Investment Officer
Following the unlawful invasion of Ukraine by Russian forces, the euro weakened progressively – dipping briefly below the 1.04 mark in mid-May – reflecting the risks and the negative impact that the proximity of the conflict could have on the economic and geopolitical outlook of the Eurozone.
In recent weeks, as Ms. Lagarde finally changed her tone with regard to the sustained and rampant inflation in the Eurozone, as expectations of rate hikes have increased and helped the euro gain some ground against most major currencies (see chart 1).
This weekend was filled with new information and developments in Europe with regard to Russia and sanctions. On May 27th, the Italian Prime Minister Mario Draghi called Vladimir Putin to discuss the potential looming food crisis due to the disruption of Russian and Ukrainian grain exports caused by the conflict.
This was followed by an 80-minute call by French President Macron, German Chancellor Scholz and Putin on May 29th, ahead of EU’s meeting on sanctions on Russia the next day. The European leaders urged Putin to engage in direct negotiation with Ukrainian President Zelensky. The issue of the transport of grains from Ukrainian ports in the Black Sea was also discussed and Putin seems to have indicated that Russia would be amenable to allow such transportation, conditional on relaxation of relevant sanctions.
These calls by the leaders of the top three economies of the Eurozone were followed on Monday (May 30th) by a meeting of EU member states, where after one month of wrangling finally energy sanctions on Russia were decided. A watered downed version of the initial proposal imposes sanction on all maritime Russian exports (two thirds of EU imports from Russia) by year end, while pipeline imports will not be affected at this point. The main takeaways from these latest developments are:
All the above means that the “pain trade” can be a rally in EUR/USD where short covering could be accompanied by a combination of likely purchase flows of by options market makers, reversal of short trends following positions and/or establishing of new uptrend positions. It also means that we may see a reduction or readjustment of some carry positions especially if an improved sentiment is translated into expectation of a more hawkish ECB. It is wise to be prepared for such eventuality – which might not be highly likely presently but could become so in the weeks and months ahead.
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