FX Update: Maximum sanctions, modest reaction in FX outside RUB

FX Trading focus: Sanctions against Russian on an entirely different level

On Friday, I foolishly indulged in thinking that the Western sanctions announced that day were about all we would get for now and that as long as this was the new status quo, risk sentiment would rebound quickly. And we did see risk sentiment recovering Friday despite the terrible realities on the ground in Ukraine. At the weekend, the situation changed dramatically, with a massive alignment on popular and government levels nearly everywhere in the West against Russia’s aggression and in Ukraine’s favor, and with far more comprehensive sanctions against Russia that look set to cripple its financial system and put all possible pressure on Russia’s political power structure, as Russian president Putin himself and an array of oligarchs are now firmly at the center of the new sanctions against Russian elites.

With Russia’s invasion bogging down, we may be in for a quick resolution if Russian discipline is lost (hopefully!) or a deepening catastrophe if Russia’s leadership ups the military pressure with a shift to new types of attacks (don’t want to expand on that thought). Regardless, Russia’s economy and anything connected with it is under enormous pressure now with the latest round of sanctions. I won’t go through a laundry list of those sanctions – those with FT access can see them here, but the most impactful are those against the Russian central bank’s ability to mobilize its reserves and against some Russian banks’ ability to access the SWIFT payments system, which makes it virtually impossible for banks to conduct international transactions. We still are missing important details on that account, including the list of Russian banks to be sanctioned. And besides the devastating impact on the Russian economy, there is the risk of considerable economic blowback into the Euro zone on the disruption of exports into Russia if counterparties can’t put together the foreign currency to make a transaction, though the impact pales in comparison to pressure on Russia itself. The ruble can go anywhere deepening on how long the conflict is drawn out and how strictly the limits on the Russian Central Bank are enforced.

For the trader, the interesting reality today is that, despite the West largely having gone most of the way to as strict a set of economic sanctions against Russia as possible, many corners of the market and many currencies are rapidly normalizing back to where they were on Friday. The two trades I discussed on Friday that might develop if no further sanctions were assessed – long AUDUSD and short EURSEK, are more or less back to where they started.

The above and the lack of more USD upside is the most telling development over the last 24 hours. EURUSD could be set for a significant rally eventually as I argue in the chart discussion below. I doubt whether the Fed Chair Powell semi-annual testimony set for Wednesday and Thursday will do much to support the greenback.

The RBA is set to meet tonight, and the degree of Aussie resilience despite maximum RBA reluctance to shift more aggressively into tightening mode suggests that it is tough to argue that there is any real dovish surprise scenario.

Chart: EURUSD
One of the most remarkable political developments in modern German history unfolded over  the weekend as Germany Chancellor Olaf Scholz declared a EUR 100 billion defense spending programme to create a German military capable of broad mobilization and conduction of strategic operations and promised to take German defense spending above 2% of GDP permanently in a dramatic shift from its historic “naivete” on security risks in Europe. It will also build two LNG terminals to diversify its suppliers of natural gas after Putin manipulated gas prices devastatingly higher this winter. This is a gamechanger for the country and for Europe, with a new hefty fiscal impulse that will raise inflationary pressure, allow the ECB to normalize yields more quickly. It is euro-positive for the medium to longer term. It may be too early now for this positive boost to the euro to find expression in the market with the situation so uncertain on the ground in Ukraine, but we’ll watch for signs that EURUSD is bidding to take out the first layer of resistance in the coming days, perhaps above 1.1300 on a daily close to start, but especially above the 1.1400-1.1500 zone eventually.