Exchange rate: the markets are preparing for war

Headlines over the weekend focused on an impending war in Ukraine.

Biden caused panic with Friday’s comments that “things could get crazy quick” and that “American citizens should go.”

Stocks are down sharply and the USD and JPY are higher in a move of risk aversion.

Another week is shaping up to be off to the worst possible start for risky assets. With only 30 minutes traded of the European session, the German Dax is already at -3% and below 15,000 while the FTSE is at -1.9% and approaching 7500. US stock futures are also lower, although less as the heavy losses have already been inflicted on Friday’s shutdown as US President Joe Biden issued a stern warning of a Russian invasion of Ukraine. “American citizens should go, should go now,” Biden said in an interview with NBC News. “We are dealing with one of the largest armies in the world. It’s a very different situation and things could get crazy fast.

Subsequent comments and a Biden-Putin phone call did not calm the situation, and the headlines over the weekend focused on the “countdown to war”. This understandably made markets jittery when they reopened on Monday and currencies are also reflecting the risk aversion environment. USDJPY is down -0.25% and AUD and NZD are down against the US dollar by around -0.6%. The euro and the pound are holding up better, but are around -0.3% lower against the dollar. Meanwhile, gasoline prices soared again and oil hit new 2022 highs at last week’s close.

Markets will frantically attempt to mitigate risk and gauge the severity of the threat and its likely consequences. Russian President Valadimir Putin certainly seems serious about war, and the United States has promised a response, but to what extent is that just posturing and what if it’s not the case ?

Markets prepare for war

Whether or not the recent escalation leads to a confrontation, markets will be pricing in the various risks ahead of time and we can see that happening on Monday. As ING points out,

“…Friday’s price action showed a shift toward defensive trading. In the forex market, the yen rose sharply on Friday, with the dollar also attracting safe-haven flows. the Swiss franc – should remain in contention until (and if) we get indications that a diplomatic solution is in sight.

bannerOn the other side of the coin, they highlight,

“…quite significant downside risks for exposed currencies – directly the ruble and indirectly all pro-cyclical currencies and especially European ones – should tensions escalate further. One pair to watch is EUR/JPY , which could return to pre-ECB levels below 130.

Stock markets also reflect the risk differential. Germany, France and Italy are all down more than -3% while Asian stocks and even the FTSE are showing relative strength. Europe will be in the eye of the storm due to its proximity to Ukraine and its reliance on trade with Eastern Europe and Russia. So far the Euro has held up quite well against European equities and is higher against the AUD, NZD and Pound, but whether this will last remains to be seen.

Hope for peace

Neither Biden nor Putin have expressed any softening of their positions, but there is still hope that the situation can be resolved through diplomatic means. German Chancellor Olaf Scholz is in Kiev on Monday for talks with the Ukrainian president. One path to peace would come from Ukraine abandoning plans to join NATO, which is a possibility according to Ukraine’s Ambassador to London, Vadym Prystaiko. He initially told the BBC that Ukraine was willing to be “flexible” on its ambition to join NATO, but has since backtracked. Even so, this is a possible way to avoid war, and markets will be watching closely for any comments from Kiev and world leaders. Any diplomatic breakthrough should cause a reversal of recent market moves.