Implications of Russia-Ukraine conflict

With both Russia and Ukraine significant producers of commodities, the ongoing conflict may result in supply disruptions and higher commodity prices. While a significant disruption to Russian supply of natural gas has so far been averted, the situation remains fluid. In oil markets, investors are weighing the potential impact of further disruptions and/or sanctions on Russian supply. This comes at a time when inventories are low and spare production capacities stretched. We see a wide range of possible price outcomes this year (see Commodity corner – full pdf on right-hand side of page). Ukraine is also a systemically important producer of a number of agricultural commodities, including wheat and corn, and of industrial commodities and alloys (like aluminium), which suggests upside risks to inflation.

Second, while the immediate currency market response to Russia’s invasion has been clouded by position adjustment and risk reduction, once risk sentiment stabilises – as we assume it will at some point – we believe that there will be greater divergence in currency reactions. European currencies dependent on energy imports and/or in close proximity to the conflict will remain vulnerable. This includes the euro (EUR), sterling (GBP), and the Swedish krona (SEK) among G10 currencies, and the Polish zloty (PLN), Hungarian forint (HUF), and Turkish lira (TRY), in emerging markets. The US dollar (USD) should hold up better, aided by the US’s energy independence. Assuming broader risk sentiment stabilises, commodity currencies geopolitically distant from the conflict may outperform. This includes the Canadian dollar (CAD) and Australian dollar (AUD) in G10, and the Chilean peso (CLP), Peruvian sol (PEN), Brazilian real (BRL), Indonesian rupiah (IDR), and Malaysian ringgit (MYR) in EM. The Chinese renminbi (RMB) should remain stable and track the broader US dollar.

Third, we believe the currencies of Central and Eastern Europe, the Middle East and Africa will retain their status of ‘most vulnerable’ given recent developments. Having already downgraded the Russian rouble to ’cautious’, we further downgrade the currency to EMFX underperformer. We also downgrade the PLN by one notch, to ‘cautious’. Recent sanctions aimed at preventing Russia’s central bank from accessing FX reserves will increase the risk of default, and prevent the country from protecting the currency. Further outflows are likely by both foreign investors and Russian residents, and this should keep the rouble under depreciation pressure against the US dollar. With the exception of the Israeli shekel (ILS) and South African rand (ZAR), all other currencies will face weakening pressures in view of their high dependence on energy prices, proximity to the conflict (PLN and HUF), as well as potential loss of tourism (TRY; see CEEMEA section).

Finally, our preferred haven currencies remain the USD, CHF, and JPY – in that order. We believe a still-robust trade surplus as well as a small dependence on fossil fuels and natural gas in Switzerland (under 3% of total energy consumption) will ensure the franc remains very well supported. On the other hand, a much smaller trade surplus and dependence on fossil fuels and natural gas (near 70% of total energy imports) will prevent the JPY from functioning effectively as a haven currency. We expect the EUR to fall below parity versus the CHF in 2022.

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