There has been a repricing of risk across asset classes with key currency crosses also suggesting a release of defensive positioning amongst investors. In particular, we have seen a so-far sustained sell-off in a previously well-bid US Dollar. Peace negotiations seemed to be making progress on Tuesday with Russia pledging to de-escalate military operations in Kyiv. Rhetoric within the market is seriously questioning the integrity of these commitments with no visible let up in attacks in besieged north-Ukrainian cities since such pledges were made. Will this matter for the Dollar and will it continue to lose ground against its key counterparts?
Markets had seemingly grown increasingly sanguine about Russia’s invasion of Ukraine with many energy commodity prices off of recent March highs. Natural gas futures, previously at the epicentre of global supply concerns are nearly 50% lower versus their peak on the prompt contract compared with prices earlier this month. The sell-off in the US Dollar therefore most likely only represents the pricing out of any residual risk and remaining defensive demand within the US currency.
From this perspective, given that the market now appears to hold a less defensive and more balanced USD positioning, an intensification and failure to meet de-escalation promises could lead to a build-up in USD strength once again. The momentary yield-curve inversion and ever-narrowing spreads in the US treasury market as we wrote about yesterday will also likely have a neutral short-term impact upon the Dollar. Whilst growth expectations are being drawn into question, US equity market peaks are generally healthy and considerably further out in time than the point of curve inversion reducing any risk of an immediate flight to safely.
Overall, as the market looks towards the May and June Federal Reserve decisions, the FX market should appear increasingly detached from the conflict in Ukraine. The Federal Reserve and market analysts alike have all been quick to note the nature and degree of monetary tightening in the United States will be data dependent. The US Dollar is therefore far more likely to experience volatility ahead of and during key data releases, including this Friday’s non-farm payrolls report, than it is from events in Ukraine.
Discussion and Analysis by Charles Porter