FX Daily: Global Risk Sentiment Shows Resilience Despite Sanctions

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USD: Sanctions and retaliation not hitting global sentiment

The Rouble and Russian assets remain very much at the centre of market focus as the currency dropped by 30% before trimming some losses yesterday (USD/RUB currently trading around 98.00) and the Russian equity markets remain closed for another day. Meanwhile, stocks of Russian financial institutions and energy companies traded in Europe have come under severe selling pressure, and yesterday the CDS market temporarily priced in a 50%+ chance of Russia’s default in the next five years. 

We have also started to see the first countermeasures in Russia against the flow of Western sanctions, both domestically and as a means of retaliation. The Central Bank of Russia’s package of measures to defend the rouble has so far seen a massive hike of the key interest rate (from 9.5% to 20%) and the introduction of tight capital controls which ban residents from sending money to foreign bank accounts, and blocked payments on new external debt. The CBR itself is facing targeted sanctions as multiple countries (including the US) have banned FX transactions with the Bank. Meanwhile, the Kremlin has closed its airspace to airlines from 36 countries, a move that risks exacerbating pre-existing supply strains.

Market risk sentiment – with the exception of Russian assets – has held up relatively well, and a number of pro-cyclical currencies have appreciated at the start of this week, boosted by another sanction-induced commodity rally. We have also seen safe-havens other than the dollar (the yen and the Swiss franc) gain some ground.

Today, markets will look for indications on whether: a) Ukraine and Russia are willing to sit at the negotiating table, after a meeting between delegations yesterday yielded no tangible result; b) the Central Bank of Russia will step in with more measures to support the rouble and liquidity in the domestic market; c) Russian banks will be excluded from SWIFT; d) Western economies will introduce import quotas on Russian commodities (Canada already plans to do so with Russian oil).

In the current environment, commodity currencies that are not geographically close to Russia (like the Canadian, Australian and New Zealand dollar) may continue to find some support, while the whole bloc of European currencies continues to look quite vulnerable. In G10, Sweden's krona, the euro and pound may suffer the most if sanctions start affecting the flow of Russian gas into Europe, while Norway's krone may keep benefiting from high gas prices. The US dollar, yen and Swiss franc remain supported in the near term amid lingering uncertainty over the conflict and the impact of sanctions.

Data is set to continue playing a very secondary role for now. In the US, the ISM manufacturing is expected to inch higher today, and two Fed members – Raphael Bostic and Loretta Mester – are set to deliver remarks.

EUR: German inflation in focus

European currencies are facing a moment of relative calm, but – as highlighted above – remain quite vulnerable to developments on the military and sanctions side. A key theme for the euro, as the European Central Bank 10 March meeting draws nearer, is whether the recent turmoil has caused a U-turn in plans for faster policy normalisation and earlier tightening: today’s CPI figures out of Germany are set to have some market impact despite investor focus being firmly on Ukraine. We expect to see a rise in February’s German headline inflation to 5.1%, in line with expectations, which may offer some support to the euro as markets may at least cement their pricing for a September ECB hike after having re-priced the timing for policy tightening in the past weeks.

CPI figures will also be released in Italy today, while the aggregate numbers for the eurozone will be published tomorrow. All in all, we expect evidence of accelerating inflation to help EUR/USD hold on to the 1.1200 level for now, although sanctions/retaliation and rising commodity prices still suggest a downward-tilted balance of risk for the pair.

GBP: Still vulnerable

The pound is set to remain highly sensitive to any news regarding a possible curb in gas flows from Russia and more spikes in gas prices, although a somewhat reduced volatility is allowing some tentative stabilisation around the 1.3400 mark in GBP/USD since yesterday. Still, we continue to see a clear prevalence of downside risks for the pair.

Domestically, Bank of England MPC members Michael Saunders and Catherine Mann are set to speak this evening, with markets likely to pay attention to any comments about the impact on policy from Ukraine’s conflict. As eurozone CPI numbers could provide some support to the euro today and tomorrow, EUR/GBP could inch higher towards the 0.8400 level it briefly touched last week.

AUD: RBA freezes the policy discussion until May

The Reserve Bank of Australia defied any expectations that it is moving towards a more hawkish stance overnight, as it delivered a broadly unchanged message compared to the February meeting. While acknowledging inflationary pressures have increased, the focus has remained on wage growth which “remains modest”, adding that “it is likely to be some time yet before growth in labour costs is at a rate consistent with inflation being sustainably at target”.

This virtually freezes the policy discussion until mid-May, when the wage price index for 1Q will be released, which may put a cap on AUD gains compared to peers that can count on ongoing central bank tightening cycles. In the near term, however, AUD appears to be in a relative soft spot when it comes to the market impact of the Ukraine conflict: not geographically over-exposed, but benefiting from risk sentiment resilience and a commodity rally has also positively spilt over into battered iron ore prices. Overnight, strong PMIs out of China also supported iron ore prices and likely helped erase any adverse post-RBA reaction in AUD.

Australia’s growth figures for 4Q tomorrow are expected to show a 3.5% quarter-on-quarter bounce, but should have a limited impact on AUD given the RBA’s focus on wage dynamics. AUD/USD may climb to the 0.7300 mark today on the back of relatively upbeat risk environment, but even though it is less exposed to the Ukrainian conflict than European currencies, its high beta to global sentiment continues to pose downside risks in the short term.