FX Trading focus: Headline reaction to Ukraine cease-fire hopes revealing. Weak sterling, Fed still behind the curve
Note: Ukraine-Russia talks winding down just before I am posting today’s piece below, with even more promising headlines suggesting a Russian is prepared to de-escalate around Kyiv and Chernihiv…
A solid recovery for the euro today materialized on a seeming focus shift from Russia on its ambitions in Ukraine towards more limited objectives in the Donbas region and Crimea, as well as on some of the statements emanating from peace talks in Turkey between the two sides. We’ll need more concrete progress here and a solid drop in energy prices to discuss proper recovery prospects, but the headline reactions are nonetheless revealing: first, the chief reaction function has been for the euro to jump higher, also versus the Swiss franc today, with the magnitude of that move suggesting some pent-up demand awaiting for these kinds of potentially promising developments, as well as some residual safe-haven status for the franc, something we find a bit surprising.
As noted some time back when EURCHF recovered so sharply off the lows earlier this month: the Swiss franc’s status as a safe haven has become heavily compromised by Switzerland joining sanctions against Russia, yet another milepost in the long arc of erosion of the banking secrecy and “no questions asked” policies of Switzerland and its banking system after the country long ago struck deals with tax authorities in Germany and the US. As well, the recent sharp recovery in global bond yields should have been a more pronounced CHF-negative. Regardless, it’s too early to know whether this headline is a sign of more promising developments for Ukraine and eventually for energy and power price inputs for the Euro zone economy. Today, Russia has been out again banging on about ruble payments for natural gas exports after G-7 representatives rejected the idea yesterday.
The euro was also sharply higher against the Japanese yen (EU yields jumping, BoJ still sitting on its yield caps) and against sterling. The latter is also interesting, in that the UK would also stand to benefit from a peace deal if this eventually sees energy prices lower – other forces may be at work here in addition to the Ukraine war impacts. I discussed the Bank of England stance in yesterday’s update after Governor Bailey fretted an “historic shock to real incomes” that makes it clear that the bank is only reluctantly tightening as the UK lurches toward a recession. The extremely negative terms of trade drag from high import prices, post-Brexit supply side limitations on real growth, and a growing fiscal drag also dog the sterling outlook. Meanwhile, the new EU and German fiscal outlays are going to at least support nominal EU growth and quite heavily so this year and for the foreseeable future, helping more of the EU yield curve into positive territory. Today, even the German 2-year Schatz is nearly in the positive yield column, trading at a mere -2 basis points. EURGBP has pulled higher, as discussed below.
Of course, this euro recovery could all turn around in a heartbeat if the hopes ginned up today’s headlines on talks lead to nowhere, but it is a dry run for what could happen if the war situation shifts dramatically for the better. The progression might look like: first a cease-fire that vastly improves the humanitarian situation. Second, perhaps at least a partial withdrawal of Russian forces from the non-Eastern areas at minimum and finally, negotiations centering on limited Russian objectives of Crimea and Donbass. The most important piece for a more stout and sustained recovery in the euro would be a fall in Russian export prices, connected with an easing of the harshest portion of sanctions against Russia’s financial system, particularly against the central bank. What circumstances are required to bring about the last of these is difficult to know.
Elsewhere, the Fed very clear still has its work cut out for it in its quest to tighten financing conditions. Stocks are rallying hard and have taken out key resistance by some measures, and as we discussed on this morning’s Saxo Market Call podcast, signs of full speculative froth are increasingly in evidence once again. High yield credit conditions have actually eased powerfully over the last couple of weeks and equity market volatility is falling like a stone. Watching the US March Conference Board Consumer Confidence number with interest, even if the market my not be, as the month saw the full impact on energy prices from the Russian invasion of Ukraine. If risk sentiment remains aggressively bid in coming days, the risks of an inter-meeting Fed move may rise quickly as it is a long wait for the May 4 FOMC meeting.
EURGBP has jumped smartly, in part on the downbeat Bank of England outlook as noted above, as well perhaps as the weak outlook for the UK economy, where the fiscal drag will be added to the tightening on real incomes from spiking inflation and from the BoE’s slightly earlier start to the tightening cycle. A potential euro positive from here would be path toward a cease-fire and a settlement that Ukraine finds acceptable (enormous if) and that opens up for hopes of cheaper energy prices for Europe, at least on a relative basis (natural gas prices, chiefly). For now, watching the key local highs into 0.8450+, as well as the 200-day moving average a bit higher that seems to have served as an important resistance level since last September. A break higher could reset the price action towards 0.8750.