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Three Market Questions: Week of March 7

CalendarMarch 7, 2022

Good morning, and welcome to Three Questions - a look at the big uncertainties facing currency markets in the week ahead.

Here are some of the things we're watching:

1. Will the unfolding global commodity price shock force central banks to change direction?

Crude prices hit the highest levels since 2008 last night, climbing in a near-vertical manner after US Secretary of State Antony Blinken said the Biden administration was in “very active discussions” with its European counterparts about launching an embargo on Russian oil exports.

The proposed ban might further limit commodity flows into global markets, where buyers are already grappling with serious delivery issues. The widening conflict has brought commercial shipping through the Black Sea to a halt, while legal ambiguities, insurance problems, settlement issues, and reputational risks are wreaking havoc on supply chains.

Prices for crucially important agricultural products - potash, urea, wheat, barley, and corn - have shot to record heights, while industrial raw materials like palladium and aluminum are trading near all-time highs. Nickel climbed more than 30 percent last night, while both the West Texas Intermediate and Brent global oil benchmarks touched $127 a barrel.

The global economy has rarely been struck by such a violent and broad-based commodity price shock - although the 1973-1974 oil price shock might offer the closest historical parallel.

Then, just as now, a geopolitical crisis - the Yom Kippur War - drove producing countries and a loosely-constructed Western alliance to deploy oil and access to the dollar as economic weapons.

The shock worsened an existing inflation problem - then partly caused by the collapse of the Bretton Woods system, now by the fiscal response to a global pandemic - and hit when monetary policy was set at accommodative levels.

Then, highly-visible gas price changes caused inflation expectations to become unanchored, leading workers to demand higher pay and unleashing the dreaded wage-price spiral. Now, narratives spread on social media networks are threatening to do the same.

But there are critical differences.

Today’s advanced economies are far less dependent on commodities. Energy efficiency has improved, with less needed to produce each unit of economic output. Oil and gas production is more dispersed, with the United States meeting most of its needs domestically. Energy sources have multiplied, with renewables and nuclear making up a larger share of output. Food and energy costs make up an ever-declining share of overall household spending.

Central banks have also built up more experience. The early seventies showed that loosening policy in response to higher commodity prices doesn’t help, and often allows conditions to overheat, building up trouble down the road. Other decades showed tightening aggressively doesn’t work either: a one-two punch comprised of rising oil prices and overly-rapid rate hikes brought most post-war economic cycles to a halt.

We suspect policymakers will try to stay the course, signalling the intent to raise rates gradually through the course of the year, while making liquidity facilities available to minimize cross-currency funding problems.

With stress levels climbing and volatility exploding, markets should expect more drama in the weeks ahead, but central bankers will do their best to avoid playing starring roles.


2. Will Lagarde catch markets off-guard?

Heading into the European Central Bank’s meeting on Thursday, the euro has fallen below 1.09 for the first time since May 2020. The region faces three spillovers from the war in Ukraine—energy price increases and inflation; confidence effects that hit demand; and uncertainty about financial exposures to Russian assets. Foreign exchange markets clearly believe the outlook is negative, but any hint that the ECB is concerned about inflation could surprise markets, potentially helping the euro bounce.

Markets will be watching for confirmation that the Pandemic Emergency Purchase Program will end in March, updated hints on when the Asset Purchase Program will end (now generally assumed to conclude at the end of September), and the quarterly staff projections on inflation and growth.

The projections are very likely to show a deterioration in the inflation outlook compared to the December release, which projected price growth running at 3.2 percent in 2022 before dropping below target to 1.8 percent in 2023. But developments in energy and foreign exchange markets could put the inflation forecast above the 2 percent target in 2023 as well, putting the ECB in a difficult situation. Meanwhile, the hit to real incomes and growth from high energy prices could be offset by plans for fiscal expansion to build energy and defense resilience.

The ECB is a single-mandate central bank with an inflation target of 2 percent, as its hawkish contingent will emphasize. At the same time, financial stability concerns stemming from the war and from volatility in intra-Eurozone sovereign spreads could make it difficult to make an overtly hawkish turn.

Part of the problem stems from the ECB’s emphasis on sequencing, with the winddown of asset purchases seen as a precondition to raising the deposit rate from the current negative 50 basis-points. Any sign the ECB might change its oft-repeated stance to allow a rate hike while continuing asset purchases would be a euro-positive signal even as retains flexibility on the balance sheet.

The fog of war certainly makes the outlook for both inflation and growth difficult to project. But even if it remains wedded to its current sequencing on steps to tighten policy, the ECB may not commit to pursuing dovish policies for all of 2022, even as the inflation outlook is deteriorating. The real conditions of the war will dominate, but a more hawkish Lagarde could surprise markets.


3. Will the currency moves that followed the onset of war persist?

Russia’s invasion of Ukraine and the resulting Western sanctions have led to a starkly differentiated response across emerging market and commodity currencies. These moves reflect judgements about the impacts of proximity to the conflict and terms-of-trade effects. Beyond the collapse of the ruble, the currencies of central and eastern Europe have been hit hard by risk aversion, even as resource exporters like Australia, Canada, and Brazil have seen their currencies gain. Some of these developments could reverse as a result of headlines, but there are structural reasons to suspect investment alternatives to Russia might continue to gain favour over the medium-term.

The impact of the conflict has been felt most obviously in global energy markets, but Russia and Ukraine are also leading exporters of wheat and fertilizer. In addition, Russia’s huge and relatively unpopulated landmass makes it a key producer of base and precious metals. Canada, Australia, and South America share similar features, making them logical beneficiaries not just of current market disruptions, but also of potential future investments that seek to substitute for Russian supply.

Vladimir Putin’s adventurism may have made Russia “uninvestable” for many reasons. It is difficult to see diplomacy taking a path that leads to a substantial abatement of sanctions. And for all the speculation about Putin’s isolation and unpopularity, regime change (should it even happen) would likely lead to increased chaos amid the fracturing of cohesion among political and economic elites.

Conversely, there has been a significant improvement in European and transatlantic cohesion as a result of the crisis. Led by Germany, the EU will be spending much more on defense and energy resilience; Sweden and Finland have applied to join NATO; and Eurosceptic populism is on the back foot across the EU.

Thus, the market’s concerns about the medium-term impact of the crisis on Europe are likely overdone, but the quest for investment alternatives to Russia is going to be a persistent theme to the benefit of resource exporters in Australia, Canada and South America.




EUR    Employment, Q4

EUR    Gross Domestic Product, Q4

USD    Trade Balance, January

JPY    Gross Domestic Product, Q4

AUD    Reserve Bank of Australia Speech, Lowe


USD    Job Openings and Labor Turnover Survey

USD    Department of Energy Weekly Oil Inventories


EUR    European Central Bank Rate Decision

USD    Consumer Price Index, February

USD    Weekly Jobless Claims


GBP    Gross Domestic Product, January

CAD    Employment, February

USD    Baker Hughes Weekly Rig Count


“Like Macbeth, Putin thought that his castle’s strength would laugh a siege to scorn. But money is not like a castle in one important way: it only works when everyone else agrees that you can use it. There was nothing intrinsic about the value of Russia’s reserves, even the $142bn in gold held in Russia itself. They only had value when they were still tied into the global financial system.

FT Alphaville: Gold fetishism has had its day

“Although China can inflict huge economic costs on the West by blocking supply chains, it is now clear that in the event of a war over Taiwan, the West could freeze China’s $3.3trn reserve pile.”

The Economist: A new age of economic conflict

“Indeed, the case levied against China’s attempts to internationalize the renminbi has been that, unlike the dollar, access to it is always at risk of being revoked by political considerations. It is now apparent that, to a point, this is true of all currencies.”

Wall Street Journal: If currency reserves aren’t really money, the world is in for a shock “The invasion of Ukraine—and China’s apparent condoning of Putin’s actions—may galvanize the U.S. political establishment and the United States’ allies in a way that brings the foreign policy debate to an end and results in a far more robust effort to compete with China (and Russia) in an effort to strengthen and revitalize the liberal international order than would have otherwise been the case.”

CSIS: China’s economy and Ukraine: All downside risks “It is hard to over-state how much German defence policy changed last weekend. In an extraordinary address to the German Bundestag on Sunday, Chancellor Olaf Scholz announced a one-off €100 billion fund for the Bundeswehr. He also committed to spending more than 2 per cent of GDP on defence every year, after Germany failed to meet its NATO spending commitments for years.”

Centre for European Reform: How the Russian assault on Ukraine will affect Europe