Late last week markets reversed some of the defensive pricing they had pushed for in the face of the initial Russian invasion of Ukraine. The reason for the relief rally last week was that the measures taken by the West fell short of market expectations. Calls for Russia to be banned from SWIFT had been vehemently rejected by German Chancellor Olaf Scholz for fear of the consequences to the supply of Russian energy. The response initially was limited to the sanctioning of individuals as the UK, European and US sanctions promised fell short of many expectations.
A severe set of economic sanctions on a significant economy is sufficient to have a meaningful impact on global growth. As the market and global economy recovers post-pandemic, a severe set of sanctions that would threaten the financial status quo and the provision of commodities would have a non-negligible impact on that recovery. Markets had braced for the worst case scenario following the early morning invasion of Ukraine taking to the haven of the US Dollar and Japanese Yen in foreign exchange and allocating money away from equities towards fixed income. When military commitments and financial sanctions came in short of expectations, some of this defensive positioning was unwound.
However, as we wrote yesterday, that was last week’s news and the headlines are rolling thick and fast. Into the end of the trading week last week, over the weekend and so far this week, the reaction from Western leaders has changed immensely. Sanctions have been stepped up to levels paralleling the response more recently taken in response to Iran with sanctions involving the SWIFT messaging system imposed, against the central bank and even the promise of military support from many nations showing solidarity with Ukraine. Germany even moved towards overhauling its defence strategy with a renewed commitment towards spending.
Due to the sanctions on the Russian central bank, there was a serious concern over FX liquidity most notably within the US Dollar. The first two months of the cable forward curve turned positive for the first time since December last year reflecting a premium for USD funding. EURUSD gapped lower at the open yesterday with an opening price some one cent lower versus the close on Friday. Investors flocked to the safety of US treasuries with the yields on US paper falling considerably. This brought into question the Fed’s commitment to rate tightening ahead of the central bank’s March meeting.
Discussion and Analysis by Charles Porter