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So far, recent events in Ukraine have not deterred central banks in Hungary and New Zealand from continuing to tighten. However, the situation remains fragile, and European currencies are expected to underperform. The first round of Russian sanctions was met with scepticism by global financial markets.

USD:

So far, the escalation of the Ukrainian crisis has had only a minor impact on global financial markets. Global equity markets have held up reasonably well over the last 24 hours, while commodity and selected emerging market currency pairs have continued to perform well in the foreign exchange (FX) space, and there is no clear sense of ‘risk off’ trading. 

So far, the market reaction to the first tranche of Russian sanctions has been relatively positive, possibly because the tiering of these sanctions has been well-publicized. Many Western financial institutions will no longer be able to trade Russian sovereign debt in the secondary market if it was issued after March 1.

Participation in Russian primary debt trading had previously been restricted until June 2021. Russian markets are closed today due to a public holiday, but we believe the moves could add 100bp to Russian sovereign borrowing costs. The rouble is also up 3% from its lows. 

Given the very uncertain situation in Ukraine, investors will continue to prefer the dollar’s liquidity and energy independence – at least when compared to European currencies. Furthermore, as central banks in Hungary and New Zealand (see below) have demonstrated in the last 24 hours, geopolitics have not prevented rate hikes of 50bp and 25bp, respectively. As a result, it appears unlikely that the Fed will be thrown off course from the start of an aggressive tightening cycle.

Today’s data calendar in the United States is light, and events in Ukraine will continue to dominate. However, with the US dollar index (DXY) heavily weighted towards European currencies, we would certainly back the dollar right now and expect DXY to return to the 97.00 area in the coming days. 

Hence For liquidity and energy independence, the dollar should be preferred.

EUR: 

Given the fallout from the Russia-Ukraine news, the euro is in jeopardy. 

This week, the euro (EUR) has held up reasonably well. This is most likely due to a risk environment that is far from ‘averse.’ Indeed, some Latin American currencies that are exposed to the commodity cycle and the Renmimbi are performing well. 

Events in Ukraine have knocked about 10bp off the pricing of the terminal European Central Bank (ECB) rate (roughly in the two-year horizon), similar to the Fed, but we suspect expectations of the Fed cycle will rebound faster. Look for ECB speakers today, including François Villeroy de Galhau, Luis de Guindos, and Pablo Hernández de Cos, ahead of the crucial March 10th ECB meeting.

These are all on the dovish side of the spectrum and may be eager to emphasise the negative effects of higher energy prices on demand. 

If Russian lines in Ukraine move further west or natural gas prices rise further, the EUR/USD could fall below 1.1280 to the 1.1220 area – or lower.

GBP: 

After briefly reaching 0.8380 yesterday, EUR/GBP is now back in the low 0.83s. We prefer this path, where at least GBP is supported by a more materials-weighted local equity benchmark and the UK government’s more aggressive re-opening schedule. 

However, keep an eye out for Bank of England speakers at 1030CET.

NZD: 

The Reserve Bank of New Zealand (RBNZ) raised interest rates by 25 basis points overnight, but surprised on the hawkish side by revising its rate-path projections significantly higher. The policy rate is now expected to rise from 1.0 percent to 2.5 percent over the next 12 months, peaking at 3.25 percent in 2023. In addition, the bank announced the start of quantitative tightening via bond maturities as well as managed sales of its holdings under the Large Scale Asset Purchase (LSAP) programme. 

All of this confirms the RBNZ’s position as the most hawkish central bank in the G10, which we believe will provide some good support for the New Zealand dollar (NZD) in the medium term.

External factors (geopolitics, volatile risk sentiment in the run-up to Fed tightening) continue to pose downside risks to the NZD in the short run, and may soon offset the currency’s modestly positive post-RBNZ reaction. In the coming days, the NZD/USD could fall back below 0.6700.