FX Update: Recession incoming with this latest energy spike.
Head of FX Strategy
Summary: Key commodity prices have ripped aggressively higher, led by crude oil globally and natural gas prices in Europe, reaching levels that in the past have led to recessions as the prices drive a tightening on the economy that the central banks have not yet manage to deliver in the major economies. How central banks respond to rising prices may be irrelevant in the near term, and they may have to focus their efforts on systemic risks triggered by the bonfire in Russian assets.
FX Trading focus: “Self-sanctioning” against Russia adds to economic, financial headwinds.
Energy prices have accelerated higher at a breath-taking pace as economic actors are piling on to the impact of the official sanctions against Russia, as a widening array of companies want to entirely disassociate themselves from Russian exposure. This “self-sanctioning” means a widening unwillingness to accept delivery of crude oil and other commodities from Russia, despite the “carve-outs” in the official sanctions to allow trade in commodities to continue.
In the past, soaring energy prices have been a decisive factor in tipping economies into recession, and as the US dollar is far stronger this time than where it was in the period of high oil prices in 2007-08 and most of 2011-14, the impact is that much greater on the global economy. Europe was arguably already headed for at least a short recession after the sustained higher power and electricity prices over this past winter. And now unless global energy prices immediately fall significantly and stay down, we are likely winding toward the next recession as soon as late this year in the US and elsewhere. Arguably, commodity markets are driving a tightening of the real economy well before the tardy Fed and even tardier ECB have ever managed to really begin tightening policy. We’ll have to see what Fed Chair Powell has to say today and tomorrow, but whether the Fed delays liftoff until after the March 16 FOMC (highly unlikely, though the odds slipped briefly below 100+% odds of a 25-basis point hike at that meeting yesterday) or whether the Fed hikes 100 basis points before July 1 as at least a couple of Fed voters have recently argued is the best course, neither scenario will drive energy prices up or down.
US President Biden’s State of the Union speech underwhelmed as Biden sought to revive the social spending package that has already failed and seemed to think that high inflation could be solved by increasing social spending and climate spending.
Europe remains the chief large victim of the fallout from Russia’s assault on Ukraine, though the impact has eased in places today as EURUSD and EURJPY have not yet really capitulated lower even if EURCHF plumbed new depths below 1.0200 this morning. The Swedish krona trades with high beta to euro weakness and the Norwegian krone tempered its recent gains despite the soaring oil prices as a bit of systemic risk has crept back into the picture, casting a shadow over NOK from a liquidity angle that offsets the support from energy prices. The worst performing currencies in Europe are those on the eastern periphery, including CZK, HUF and PLN. The Hungarian forint (HUF) bears watching as the weakling of the lot and ahead of the Hungarian election in early April as the opposition tries to paint Prime Minister Orban as a lackey for Putin, even if Orban has supported the EU sanctions and seems to have turned his back on Russia’s leader after a long period of chumminess.
As we discussed on this morning’s Saxo Market Call podcast, when there has been a bonfire of assets like everything Russian- and Russian oligarch related of late, it sets off a vacuum in the liabilities side of the equation in the financial system, especially for counterparties in Europe’s banks. The market has been caught off guard by this and is suddenly seeking price-insensitive liquidity in the form of sovereign EU bonds (whether German, Italian or otherwise) and it came at a time when the ECB was supposedly transitioning to a more hawkish shift in its inflation stance at the March 10 meeting next week. Instead, we may be looking at the need for central bank liquidity provision – something that would likely prove more controversial and far less broad-based than in other “bailout episodes” of the recent past.
Somehow, asset markets, especially equities somehow continue to try to put a brave face on things, but very significant risks remain and this could still go anywhere – and in either direction. The potential is not one way, after all, as a positive shock for markets is a possibility on a sudden breakthrough in diplomacy, a shock Russian military retreat or even regime change in Russia, etc. We don’t care to elaborate in the negative direction, but the destruction of the much of the world’s financial and trade interface with Russia is severe enough even if the status quo developments merely persist and deepen.
Bank of Canada is up today and could be briefly distracted by BoC guidance, but have to believe this will err on the cautious side even if Macklem and company achieve lift-off today with a 25-basis point hike that is priced as a near-certainty.
The US ADP payrolls change for February was out just before this piece went live – with February payrolls up a robust +475k v. +375k expected, but January revised from -301k to +509k!
The Swedish krona is the G10 currency showing the most beta to the fundamental pressure on the European economy and financial system from the fallout of Russian sanctions. If we widen the lens, the pressure on CEE currencies is worse still. EURSEK is one of the few pairs outside of EURUSD where one might express a limited risk, larger reward options structure (long put spreads for EURSEK and/or long EURUSD call spreads) that hopes for a reversal of the Russian invasion and with it a sudden reversal in energy prices over the next one- to three months. Not as a prediction, but as a way to express hope without risking more than a modest premium outlay. One approach would be put on a third of a position now and two more modest positions totaling one overall position in the event of a significant market deleveraging event. Already, EURSEK is working into the higher bits of its historic range, reaching into territory that only traded during the worst of the panic around the pandemic outbreak.
Table: FX Board of G10 and CNH trend evolution and strength.
Euro-centric themes continue to stand-out in the FX trend strength, something that could certainly extend or reverse violently, depending on the developments on the ground in Ukraine and in Russia’s leadership. Elsewhere, the commodity angle is clear on the strong side, but could find itself suddenly in trouble on any negative shock to commodity prices, ironically, or any negative shock to asset prices. This odd period of vicious commodity price gains with little major risk sentiment fallout doesn’t feel sustainable.
Table: FX Board Trend Scoreboard for individual pairs.
Would note again today the increasingly extreme commodity FX readings against euro and SEK as something that is getting hyperextended and likely to reverse very hard once the peak is achieved.
Today’s Economic Calendar Highlights (all times GMT)
- 1500 – Bank of Canada Rate Decision
- 1500 – US Fed Chair Powell to speak before House Panel
- 1530 – EIA's Weekly Crude Oil and Fuel Stock Report
- 1600 – ECB Chief Economist Lane to speak
- 1900 – US Fed’s Beige Book
- During the day: OPEC+ decision on production for April
- 0145 – China Feb. Caixin Services PMI
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