Saqib Iqbal Ahmad

NEW YORK (Reuters) – Fallout from Russia’s invasion of Ukraine may be setting the stage for more gains in the dollar, upending investor expectations for a weaker greenback as geopolitical uncertainty and worries over European growth raise the U.S. currency’s appeal.

U.S. Dollar Currency Index has increased 3% to reach its highest point in 21 months. This is due in part to investors looking for protection from volatility in the markets that have hammered stock prices around the world and caused wild swings in commodities prices. Russia describes its actions in Ukraine as a “special operation.”

It will depend on how the Federal Reserve Bank and the European Central Bank proceed in normalizing monetary policy. While investors are betting the Fed will likely push through several rate increases this year to fight surging inflation, many believe the ECB faces a tougher slog, with soaring raw materials prices posing a greater threat to Europe’s energy-dependent economy.

The euro has fallen to its lowest point against the dollar for more than two decades due to bets that the yield gap between the U.S.A and the euro zone will widen. Despite a surprisingly hawkish shift at the ECB’s monetary policy meetings, the euro was 0.8% lower against the dollar on Thursday afternoon.

Bipan Rai of CIBC Capital Markets, North America head of FX strategy said that it was wrong to expect the euro to appreciate in January after months of strong dollar.

Investors were surprised by the recent price movement in both currencies. This is despite the fact that the dollar rose 6.3% last year due to hawkish Fed rhetoric. Reuters polled a range of analysts at the end January, and they all expected that the dollar would remain steady while predicting that the euro will rise 1.5% over 12 months.

Eric Leve (chief investment officer, wealth and investment management company Bailard) stated that “everything that made the bullish case earlier in this year for the euro now makes it a very bearish situation.”

While Leve had started the year expecting the euro to strengthen at the dollar’s expense, he has now trimmed exposure to European equities and is looking to hedge euro currency risk.

An extended rise in the US dollar’s value could have wide-reaching implications on markets and the U.S. economic system. A strong currency can have a negative impact on domestic exporters’ profits, but it may also be beneficial for the Fed to manage inflation. The Fed recently recorded its highest annual rise in over 40 years. A weaker euro, on the other hand, could lead to higher consumer prices within the euro area.

Markets are pricing the fed funds rate to rise by more than 165 basis points in the U.S. this year, starting with a widely anticipated increase at next week’s Fed meeting. Markets are pricing in around 43 basis point interest rate increases this year, confirming ECB rate rise expectations.

Thursday’s announcement by the ECB indicated that asset purchases would be ended in the third quarter. The ECB also raised inflation expectations and trimmed its growth outlook.

Nuveen analysts stated earlier in the month that $120 per barrel would reduce growth by two percentage points off of the euro area. This is due to part to America’s higher domestic energy supplies and lower taxes.

Aashish Vijas, investment director, Resonanz Capital, a Frankfurt-based investment advisory for hedge funds, stated that “there is more fear on the pond”

Robin Brooks (chief economist, Institute of International Finance) stated earlier this week, that the euro could fall below $1.00 if markets react to “a major adverse surprise to the euro area.” Recently, the currency traded at $1.0987.

Many believe that the dollar will weaken in the coming year.

Steve Englander is the head of Global G10 FX Research at Standard Chartered. (OTC:) He believes that the Fed will offer less rate increases than anticipated and that the war in Ukraine would end. This will leave the euro at

By year-end, $1.14

Paresh Upadhyaya is director of Fixed Income and Currency Strategy at Amundi US. However, it may cause some more problems for the Euro in the immediate term.

Upadhyaya said that “just north of parity” is the likely trough in euro, and is holding a very short position.