USD: The dollar gets the flight-to-safety bid

The news early this morning that Russia has launched a major military offensive across Ukraine shocked the world. As we discussed in our market review yesterday, forex markets had shifted to a benign interpretation of events – perhaps the Russian incursion would only stop in rebel-held areas. This thesis was swept away by developments overnight and prices of FX-traded volatility jumped understandably.

The cross reaction of the market is also understandable. Brent prices have jumped $100 and European natural gas prices are also expected to rise – with no sufficient alternative to Russian gas for Europe. Equities are down around 3% in Asia and European equities and corporate credit are expected to come under heavy pressure today. In bond markets, we have seen an upward flattening of yield curves, consistent with investors pricing in weaker growth. A key question will be whether investors are pricing lower terminal rates for tightening cycles or whether the energy price shock is reinforcing fears of stagflation and whether rates at the short end of the yield curve are holding up. good.

Today the focus will be on the Western response to Russian aggression. In the United States, carefully monitor the progress of the Bill Menendez in Congress. This has been dubbed the ‘Mother of All Sanctions Bills’ and given the events overnight, it seems that its progress is very likely. The question will then be which Russian financial institutions are targeted by severe financial sanctions. Russia closed local markets today, but USD/RUB traded at 90 and, as we mentioned in yesterday’s report, it wouldn’t be surprising to see a two-level market to develop again – that is, an onshore and offshore ruble trading market – even though the ruble is a deliverable currency.

Given the uncertainty, expect forex markets to trade in the direction we discussed in yesterday’s report. Namely, those geographically closest to the crisis and exposed to the story of imported energy – the CE3 currencies in particular – to remain under pressure. The Czech koruna and the Hungarian forint have already fallen by 1-1.5% today. The Swedish krona also looks exposed – a dovish central bank and small open economy exposed to weaker European growth prospects.

Although the Federal Reserve tightening cycle may be re-priced lower, we would still prefer the Dollar to outperform Europe at this time. Trade and energy ties with Russia are tiny compared to Europe. And dollar liquidity will be in demand at very uncertain times like this. As discussed yesterday, we still appreciate the rise in the DXY (heavily weighted against European currencies) to 97.00.

And in terms of spheres of influence, the Chinese renminbi remains strong and asserts itself as a safe haven, a reserve currency. Commodity-linked currencies that trade against the renminbi, such as the South African rand and Brazilian real, as well as those officially managed against the renminbi, such as the Singapore dollar, should continue to perform well.