FX Update: Euro and its periphery continue to suffer worst of Ukraine impact

FX Trading focus: Euro and its periphery continue to get worst of it from war in Ukraine.

European equity markets are capitulating today on the weight of the implications of the war in Ukraine and its ongoing fallout, and the euro itself is capitulation as well, with EURUSD trading sub-1.1000 and EURCHF well on its way to parity, while EURJPY. As I note below, EURAUD has been a theme trade on the fallout from Russia’s assault on Ukraine as Australia is strong in the very commodities that are most heavily impacted by the conflict: it is a top six wheat exporter and the world’s largest exporter of LNG.

An extra twist for CEE from the war in Ukraine is flagged by a Bloomberg article that discusses Ukrainian workers “downing tools and ditching trucks” to head back to Ukraine to fight the Russian assault, with significant implications for these economies, where wage growth has continued to outstrip even the high recent inflation levels. A real growth recession is coming there and CEE currencies are under considerable pressure. Before the pandemic, between 2.2 and 2.7 million Ukrainian migrant workers were working abroad – many of them in Poland. Yesterday, the Hungarian central bank hiked the deposit rate 75 basis points to 5.35% and the market hardly blinked an eye.  The National Bank of Poland bank meets next week and is expected to hike the rate 50 basis points to 3.25%, but will need to do more to slow the zloty’s slide if the war impact continues to deepen. EURCZK is possibly the first place to look to take risk in fading this move, as Czech has gigantic foreign reserves it was already out announcing this morning that it had mobilized to stabilize the koruna and EURCZK shorts offer solid 500 basis points of carry that will likely increase further with further Czech central bank policy tightening.

Sterling has been firmer in part on the very weak euro, but possibly also on the idea that security concerns for EU countries will motivate EU countries and fellow NATO members to maintain a strong defensive front against Russia, as the UK has the strongest military presence in Europe. No incentive, in other words, to draw up new battle lines, etc. on customs issues linked to Norther Ireland, etc.

The US February ISM Services Index release yesterday dropped sharply to 56.5 versus 61.1 expected and 59.9 in January. The fall-off from the record levels registered a few months ago is impressive, but as this is a “diffusion” index, it is impossible for conditions to maintain a strong pace of relative improvement over time. 56.5 is still a solid number, even if the deceleration is notable. The employment sub-index fell to 48.5 versus 52.3 in January and was the worst since August of 2020. As an acceleration in gas prices and food prices has been set in motion only starting in the very last days of February, the impact of rising inflation on confidence and economic activity will deserve close scrutiny for the March data cycle – higher energy prices have preceded every recession in modern US economic history. Wheat prices are particularly scary, as we are near record levels and Chicago wheat futures have been pinned at limit up overnight – food demand is not particularly elastic.

Today is US Nonfarm payrolls data, with possibly more focus on the Average Hourly Earnings as an input for the persistence of inflation. Next week’s US February CPI print is expected at 7.9% and that is before the latest acceleration in key commodity inputs.

Chart: EURAUD
The EURAUD pair has been about as direct an expression of the fallout from the war in Ukraine as any other G10 pairing, if one is not thinking along the usual “risk sentiment” fault-line, as with EURCHF, etc. . As noted above, Australia’s impressive portfolio of commodities exports include those most under pressure directly from the war, but also from the sanctions on Russia, as metals prices have also shot higher in recent sessions. Of course, this also builds energy for an incredible reversal in the hopeful event we see a change of the situation on the ground in Ukraine.