FX Talking: Tectonic shifts in FX

The tragic events unleashed by Putin’s war in Ukraine have also triggered major shifts in global financial markets, including FX. The net macro-financial effect is a stagflationary one – where the world will be left with lower growth, higher inflation and greater uncertainty. Understandably, the dollar will stay in demand as long as the war continues

European currencies have borne the brunt of hostilities, where trade and financial linkages leave their currencies in harm’s way. It is not just geopolitical risk, but also the exposure to Russian fossil fuel imports – imports which cannot be easily substituted. Europe is suffering a negative income shock – and one which policymakers may seek to address with a fiscal solution.

Expect EUR/USD to trade in a 1.05-1.10 range near term. A Fed still determined to hike – by 4-6 times this year – will keep the dollar bid. Eastern European currencies remain – literally – on the front line. Local central banks are using rate hikes and now FX intervention to limit losses. We would expect a quick snapback in these currencies were the crisis to take a positive turn.

The same probably cannot be said for the Russian Rouble, where counterparty sanctions suggest it is moving to non-deliverable status, with an uncertain future depending on sanctions. The commodity supply shock has also triggered winners and losers around the world, depending on which side of the import/export ledger one sits. We are concerned by the near-term fate of most emerging currencies, however.

The freeze of Russian assets means that the buy-side will have to sell other liquid investments to meet redemptions. Outperforming has been the Renminbi – enjoying its newfound status as a safe-haven currency. The increase in Russia-China trade will inevitably now see greater use of CNY.