The euro and the pound will slide if a military conflict breaks out
- Risk appetite taken hostage by Ukraine
- Strong fluctuations for defensive currencies
- Energy prices hit new highs in 7 years
- Europe and the Euro vulnerable to the energy crisis
- Market reaction still contained
- Looking for comparisons with Crimea
- New headaches for central banks
Big market reactions to Ukrainian headlines, euro and pound set to drop if military conflict erupts
Overall volatility in the forex market will remain high in the near term, especially as markets react instantly to any headlines about Ukraine.
Sudden moves between asset classes will also further complicate central bank interest rate decisions and trigger increased volatility.
According to ING; “This week should be crucial to assess the evolution of the geopolitical situation in Ukraine.”
If the situation deteriorates, there will be gains for the Japanese yen, Swiss franc, US dollar and gold. Oil prices would also jump again.
The Euro would lose ground and there would be a slide for currencies such as the Australian and New Zealand dollars while the British Pound would also be vulnerable.
If there is a sustained easing of tensions and signs of de-escalation amid diplomatic success, these trends would reverse with losses for the Yen and the Swiss Franc. The euro would strengthen against the dollar and the pound would also gain some support.
Risk appetite held hostage by Ukraine
Stocks on Wall Street fell sharply on Friday evening and European stocks also fell sharply on Monday. The German DAX index fell, with the FTSE 100 index losing nearly 2%.
Susannah Streeter, senior investment and market analyst at Hargreaves Lansdown, noted the additional threat to investor confidence; “Just as the COVID storm seemed to be receding, the growing expectation of an invasion of Ukraine is the new threat now worrying investors.
She added; “The twin problems of impending conflict and soaring (oil) prices are likely to be behind the fall in investor confidence.”
Gold posted 8-month highs around $1,880 an ounce before falling back to near $1,850.
Victoria Scholar, Head of Investments at Interactive Investor commented; “Geopolitical tensions between Russia and Ukraine sparked nervousness earlier this week, with European markets opening in the red, falling to three-week lows driven by travel and leisure and the banking sector. “
Added Neil Wilson of Markets.com; “Banks are affected because not only are they exposed to Russia through outstanding loans (SocGen, UniCredit, etc.), but they are also concerned that Russia will be cut off from the Swift payments network.”
The mood, however, turned markedly more upbeat on Tuesday following reports that Russia had moved some troops away from the Ukrainian border and stocks rallied.
MUFG noted; “Markets could suddenly turn to a development in Ukraine, which means aggressive risk-taking is likely to remain subdued for now.”
Strong fluctuations for defensive currencies
The yen and Swiss franc posted sharp gains on Monday as demand for defensive assets increased. However, there was a reversal on Tuesday as risk appetite picked up.
Unicredit commented; “The tensions over Ukraine are affecting the FX market through the usual channels, i.e. favoring safe-haven currencies over high-beta currencies and increasing implied volatility.”
Any further escalation in the Russian-Ukrainian conflict would likely trigger strong selling in global equity markets.
In this environment, there would also be strong demand for the Japanese yen and the Swiss franc, with gold also likely to rally higher.
Risk-sensitive currencies would tend to be vulnerable, particularly the Australian dollar.
ING commented; “These two currencies (the US dollar and the yen) – along with the Swiss franc – should remain in contention until, and if, we get indications that a diplomatic solution is in sight.”
Energy prices hit new highs in 7 years
Oil prices also strengthened strongly with global benchmarks at 7-year highs earlier this week. Brent crude peaked above $96.0 per barrel before falling back below $94.0 per barrel on Tuesday.
If Russia takes military action, the United States and Europe have threatened to impose severe sanctions on Russia, which would increase the risk of a decline in Russian crude exports and put additional upward pressure. on oil prices.
Giovanni Staunovo, commodities analyst at UBS noted; “Market participants fear that a conflict between Russia and Ukraine could disrupt supply.”
OANDA analyst Edward Moya added; “If a troop movement occurs, Brent crude will have no trouble rallying above the $100 level. Oil prices will remain extremely volatile and sensitive to progressive updates regarding the situation in Ukraine.”
Given their energy exports, strong oil prices will provide some protection for the Canadian dollar and the Norwegian krone.
Energy price movements would also dampen the impact of the pound sterling to some extent with reduced margin of gains if tensions ease.
Europe and the Euro vulnerable to the energy crisis
Currency markets will be sensitive to changes in energy prices, particularly given the impact on inflation and growth trends.
A further surge would trigger a fresh wave of unease over the eurozone outlook.
According to Commerzbank; “Europe’s dependence on Russian energy makes the cyclical economic performance of the eurozone particularly vulnerable in the event of an escalation of the conflict in Ukraine.”
The consensus is that the eurozone will potentially be the most vulnerable.
ING noted; “The common currency looks a bit more vulnerable at this point, also due to its sensitivity to the Ukrainian situation.”
Nomura added; “Any invasion of Ukraine would likely lead to risk aversion in the markets and a run into safe havens such as the USD.”
According to Scotiabank; “EUR/USD risks losing up to 1.10 if Russia enters Ukrainian territory in the next few days.”
Given its sensitivity to risk conditions, the pound would also tend to slide if Ukraine fears escalate.
Scotiabank added; “A Russian invasion of Ukraine would likely result in sterling losses below 1.34 with a possible test of the 1.32 zone.”
Market reaction still contained
Although there were significant moves, the overall market reaction remained relatively contained.
ING commented; “Yesterday’s support at the 115.00 USD/JPY level is, in our view, a clear indication that the market is far from pricing a black swan scenario – i.e. a full fledged invasion. from Ukraine. There is therefore considerable downside risk for high-beta currencies, and in particular European currencies, if tensions escalate further. .”
Marshall Gittler, head of investment research at BDSwiss Group, also said market conditions were relatively calm; “While the one-month EUR/USD risk reversal has moved into negative territory, showing that people now want downside protection, there is little difference between their one-month view and their one-month view. If they were worried about the war, the one- and two-month RRs would be significantly lower than the long-term ones.”
Looking for comparisons with Crimea
Markets inevitably look to historical comparisons to try to judge the potential impact this time around.
In this context, the Russian invasion of Crimea in 2014 was analysed. The overall market reaction was limited, with EUR/USD losing ground as tensions increased, but not weakening further after the actual invasion.
According to Gittler of BD Swiss; “I don’t know how comparable the two events are. The Russian invasion of Crimea was limited in scope and did not involve anyone outside the country. This time, NATO may well get involved, which could lead to a much larger conflagration. We saw a big move in gold and silver on Friday.
New headaches for central banks
Higher energy prices were a big part of the inflation spike, with the euro’s inflation rate hitting an all-time high.
Global central banks have shifted to a more hawkish market bias in response to inflationary concerns and a further spike in oil prices would heighten those inflationary concerns.
However, there will also be heightened concerns about the growth outlook as high energy prices undermine support for consumer spending.
In this context, the central bank will find it even more difficult to define its policy during the next meetings at least.