FX Update: The commodity angle versus the liquidity angle.
Head of FX Strategy
Summary: Commodity linked currencies have shown considerable resilience over the last few sessions as the impact of the Russian invasion of Ukraine is absorbed by commodity markets. Those currencies may continue to show resilience relative to prior cycles, but if we do suffer a new wave of proper deleveraging, the liquidity angle could yet trigger significant volatility in FX along traditional lines and support the traditional safe havens of the US dollar and Japanese yen.
FX Trading focus: The commodity angle versus the liquidity angle
The last couple of sessions have shown a remarkable resilience in some measures of risk sentiment, including the broader equity market and some normally pro-cyclical currencies – mostly those linked to commodities, although arguably it is the fundamental support of ripping commodities prices that is driving the latter more so than risk sentiment per se. To take a couple of examples, the AUD has absorbed recent events quite well as investors may be considering Australia’s impressive portfolio of commodities exports, which tick nearly all of the boxes for commodities exposed to the Russian invasion, including wheat (In 2019, Russia was the world’s top exporter, with Ukraine ranking fifth and Australia sixth) and LNG (Australia is world number one in LNG exports!). Elsewhere, the Norwegian krone is on fire and CAD is managing to find a bid on the fresh boost to energy prices today.
But let’s not fool ourselves – if the broad risk sentiment situation deteriorates badly again, for whatever reason, this attempt at nimbly picking winners due to the real-world impact of rising commodity prices could be quickly derailed by considerations of safe haven seeking. And in the case of a war and the knock-on risks in the financial system of sanctions, or a sudden seizure of Russian energy flows, the risk remains large of a sudden risk-off move out of the blue that could at least briefly spike volatility across asset classes. On Friday I looked at the irony we might see a more productive tone in risk sentiment this week if sanctions were not deeper than those announced – but the comprehensive sanctions announced at the weekend together with the speed with which a broad swath of companies are simply pulling out of Russia, suggests the risk of a significant firestorm through the global financial system.
So even if there are compelling arguments for an extension of many of the recent commodity currency moves, traders need to consider hedging positions (and we even have to consider the risk-positive scenario effect in FX in which a sudden détente in Ukraine leads to a collapse in energy prices, especially for Europe). There are a few signs of systemic risks picking up in the financial system, as we discussed in this morning’s Saxo Market Call podcast, including counterparty risk in the US banking system (Citigroup today out indicating a $10 billion exposure to Russia). As well, we have the strong bid all along the curve in US treasuries and even for German bunds, where the yield is negative today after trading as high as +21 basis points yesterday, which suggests safe haven seeking. Corporate bond issuance, particularly for junk has been disrupted for nearly a month as spreads widen and market conditions deteriorate. Yes, we have seen some remarkable resilience this week and we can safely assume that central banks know the drill for preventing any real systemic event, but accidents can still happen here.
And the current backdrop can’t come at a more awkward time for the US Fed, which is navigating tremendous pressure to do something about inflation from the White House and is gearing up for rate lift-off at the March 16 FOMC meeting when an aggravated counterparty risk situation in the global banking system could be working its way through the system on a bonfire of Russian-held assets that may require targeted easing measures. Will be watching Fed Chair Powell’s comfort levels – or lack thereof – in testimony before Congress tomorrow and Thursday. That testimony comes in the wake of tonight’s State of the Union address from US President Biden, who is under siege from every direction and suffering the worst approval ratings of his presidency.
As we have noted recently, the AUDUSD continues to bounce back like a rubber ball after every risk-off inspire sell-off as traders and investors are likely focused on Australia’s strong portfolio of commodities exports (more above). As well, the long cautious RBA is less of a drag now that central rate expectations have eased off elsewhere – particularly in the US this week. Overnight, the RBA waxed dovish once again, specifically citing Ukraine as a new risk to the forward outlook and clearly indicating the bank is in no hurry to begin its rate tightening cycle. The technical situation looks promising, if still needing a solid close above 0.7300 to suggest an upside break, and as we noted, headline risk triggering significant market volatility could derail the bullish hopes, as could, ironically, a sudden détente in Ukraine (please!) that leads to a collapse in European energy prices.
Table: FX Board of G10 and CNH trend evolution and strength.
Non-commodity euro-centric FX is suffering the most, it is clear to see here – have to imagine this I soon about as extended as it can get as a further explosion in commodity prices will eventually eat into the growth outlook as it pulls the weight normally done by central bank tightening.
Table: FX Board Trend Scoreboard for individual pairs.
Note the extreme levels in some of the commodity FX/European currency trends north of 6 – the ability for these to extend is likely constrained beyond the very nearest term.
Today’s Economic Calendar Highlights (all times GMT)
- 1330 – Canada Dec. GDP
- 1500 – US Feb. ISM Manufacturing
- 1830 – UK Bank of England’s Saunders to speak
- 1900 – Uk Bank of England’s Mann to speak
- 1900 – US Fed’s Bostic (Non-voter) to speak
- 1900 – US Fed’s Mester (voter) to speak
- 0030 – Australia Q4 GDP
- 0200 – US President Biden State of the Union address
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