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All Crossed Up By the Invasion - Global Exchanges

FICC Podcasts 08 mars 2022
FICC Podcasts 08 mars 2022


Disponible en anglais seulement

In this week's episode, we take a walk through the FX landscape as a result of the events in Ukraine. The point of our survey is to identify currency pairs that have either moved too much as a result of those events or that haven't moved enough given the shifts in related financial prices and underlying economic fundamentals.


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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:

Hi, welcome to episode 35 of Global Exchanges, a podcast about foreign exchange markets and related issues. I'm Greg Anderson. For this week's episode, my co-host, Stephen Gallo and I will take a walk through the FX landscape as a result of the events in Ukraine.

Greg Anderson:

The point of our survey is to identify currency pairs that have either moved too much as a result of those events, or that haven't moved enough given the shifts in related financial prices and underlying economic fundamentals. The title for this episode is, All Crossed Up By the Invasion.

Stephen Gallo:

Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges presented by BMO Capital Markets.

Greg Anderson:

Hi, I'm Greg Anderson, a New York-based FX strategist. I'm Stephen's co-host.

Stephen Gallo:

In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:

We strive to make this show as interactive as possible. So don't hesitate to reach out by going to bmocm.com/globalexchanges. Thanks for joining us.

Speaker 3:

The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries.

Stephen Gallo:

Okay. So thanks for tuning into Global Exchanges. And for the record, we're recording this on 8th March 2022. And I think we can agree, Greg, that the events in Ukraine, which you alluded to in the intro began in earnest on February 24th. So for that reason, we can measure changes in financial variables and asset prices as a result of the events in Ukraine from the close on the 23rd. Does that sound good to you, Greg?

Greg Anderson:

Yeah, I think that makes a lot of sense, Stephen.

Stephen Gallo:

Okay. So with that in mind, and getting back to the main point of this podcast, we want to identify exchange rates that have either moved too much as a results of the events in Ukraine, or too little. And I think we're going to spend a lot of time discussing non-dollar cross rates.

Stephen Gallo:

On that note, Euro Canada, EURO/CAD is still of interest, I think Greg. We had a call for a move lower in the pair in our annual outlook. We did two podcasts about the downside risks in EURO/CAD last autumn, and we wrote about an extension in the cross below 140 last week. And the low thus far is about 137.60 in this pair. So Greg, let's start off by you giving us a big picture idea of how much EURO/CAD has moved in relation to the price of crude oil.

Greg Anderson:

Using February 23rd as our anchor date, the EURO/CAD cross closed at 144 to the figure on that date. It is now trading just a smidge below 140. With rounding, the moving the pair since the invasion started is 2.9%. Now the contrast, Canada produces a heavy grade of crude known as Western Canada select.

Greg Anderson:

It closed at $79 a barrel on February 23rd and is trading at $112 in change right now. In percentage terms, WCS is up 35% versus just a 2.9% move lower in EURO/CAD. Of course, it's important to keep in mind that oil is a whole lot more volatile than FX. So forgive me if we start to get just a little bit quanty here, but I think we have to, in this case.

Greg Anderson:

I think the easiest way to scale the oil move and the EURO/CAD move so we can compare them is to first compare each to their respective daily standard deviation of returns. So for WCS, the standard deviation of daily returns for the 260 trading day period ending February 28th, 2.86%. For Euro Canada, the exchange rate standard deviation of returns, 0.42%.

Greg Anderson:

What do we do with that? Well, here's the relevant comparison I think. As a result of Russia's invasion of Ukraine, WCS crude has moved up 12 daily standard deviations, but Euro Canada, the exchange rate has only moved seven daily standard deviations. So that's where I'm going to say that the oil move has been almost twice the size of the Euro Canada move. And I'm going to flag that pair as perhaps one that hasn't moved enough yet.

Stephen Gallo:

That makes a lot of sense, Greg. And what I think we have to do particularly in this environment is not lose sight of the key fundamentals. We've seen a bit of a recovery in the Euro across the board today, March 8th. And I've noticed that there seems to be this growing belief in the market that the entire energy supply shock, which could be coming to Europe and the world from Russian sanctions is in the price of the Euro right now.

Stephen Gallo:

I don't think that's the case at all. I think what's largely in the price already is the view that key players in Europe, most notably Germany, won't enforce a ban on Russian oil and gas imports based on what leading German politicians are saying, and based on the fact that the UK and the US are going ahead with their own oil import bands on Russia.

Stephen Gallo:

But I'm not confident that the full extent of the potential supply disruption related to the events in Ukraine has been discounted by the FX market yet. So that's the first key fundamental element worth noting in my view. The second key element is that although the fiscal response coming from the EU through jointly guaranteed debt, that will lessen the economic impact of an energy supply shock.

Stephen Gallo:

It's not going to allow the block to grow its way rapidly out of the shock. So over the medium term, I think the ECB is going to have a big economic growth headache and the Euro, an even bigger balance of payments headache to deal with than we had previously been expecting.

Stephen Gallo:

And I think when you look at the facts as they currently stand, assuming there is not a major deescalation between Russia and the West, this is the cold hard reality of the situation. Of course, does not mean that other economies besides the Euro area won't also have a growth headache at some point, but Europe's probably going to feel the brunt of it I think.

Greg Anderson:

In Canada's case, there's likely to be a bit of a demand destruction for everything other than energy, simply because energy will take up much more of the country's discretionary income. And the inflation shock will undoubtedly be worse. And with less potential for the bank of Canada be able to mitigate the inflation shock because the financial environment is now likely to be deemed too fragile to risk upsetting with something like a 50 basis point rate hike or the rapid on set of aggressive QT.

Greg Anderson:

So yeah, there are some negatives for Canada's economy, but they're not nearly as acute as for Europe's. And I point out that the money market has already responded to this by basically pulling out about one rate hike from this year's OIS curve relative to where it was at on February 23rd. Then it's worth noting, there are some positives from this for Canada. For example, when I was talking about WCS earlier, it could be a very good substitute for Russian crude, which is similarly heavy, if only it could be brought to sea.

Greg Anderson:

The democratic party's sweep of the 2020 election seemingly killed the most economically sensible prospect of getting that oil to sea because the Biden administration came in and almost immediately de-permitted the Keystone XL pipeline project. If Europe needs a long term solution for replacing heavy Russian oil, we may get a rethink of that pipeline or other proposed pipelines or rail linkups, et cetera.

Greg Anderson:

We're talking about stuff that could conceivably bring FDI into Canada, in addition to just the incremental dollars that get added to Canada's trade surplus as a result of the high price of oil that Canada sells to the US. And I'll just point out on that note that this morning, Canada released a monthly trade surplus for January, that was the biggest since 2008. And of course, that was pre-invasion with oil in the 70s. Wait until we get March trade data released in May.

Greg Anderson:

So that's where I think the preponderance of fundamental shifts as a result of the invasion are almost borderline CAD positive. And they're certainly CAD positive if we're comparing it to the Europe. So I would tend to view this little bounce in EURO/CAD over the last day or so up to one 40-ish as kind of a gift to FX traders. Sell the thing, looking for mid 130s in a few months or maybe in a few weeks.

Stephen Gallo:

Okay. So that's Europe out of the way for the time being. Let's migrate eastward to the Asia Pacific region. We're talking a lot and we have been talking a lot about commodity importing versus commodity exporting currencies, Greg. And when we consider the balance of risks for key commodity importing currencies, economies in Asia, we can exclude the Japanese yen.

Stephen Gallo:

To me, Greg, it seems a lot like the yen is caught in the cross hair, but just not moving. And in the same breath, we haven't seen much movement in the Aussie since February 23rd. And look at dollar yen, still on a 115 handle. So I've got to imagine that commodity prices are playing a role in dictating where these currency pairs are trading, but maybe the FX market still hasn't discounted certain fundamentals into the price by enough. What do you think, Greg?

Greg Anderson:

Obviously, the APAC economies are a lot further away geographically from the Russia Ukraine conflict, but they aren't removed from the commodity price effects. Japan's number one import is oil. So the doubling of oil and prices this year is just undeniably bad for the yen.

Greg Anderson:

For Australia, it's key exports are metals and energy. In fact, Australian exports of things like coal and nickel are a great potential substitute for Russian supplies of those things. I don't have my own Australian export commodity price index. I just use the central banks, which is unfortunate that it's just published monthly.

Greg Anderson:

It will be fascinating to see how much higher it ends up for March. But for now, I would use Bloomberg's base metals index as kind of a loose proxy. It is up 10% or roughly eight daily standard deviations over the invasion period. So if I compare that to Aussie yen, which is up 0.9% or roughly two standard deviations of daily returns, we've got a commodity price move that's four times the size of the exchange rate move.

Greg Anderson:

So I think this is another exchange rate that probably hasn't moved enough to reflect the shift in commodity prices and underlying balance of payments in economic fundamentals. With today's pullback to the low 84s in Aussie yen, I think the pairs are screaming by here. I think it easily go up to 87 or 88 over the next few months. And I think that's the size of move that would catch it up to the commodity price moves.

Stephen Gallo:

So Greg, we've talked about two exchange rates that we think haven't moved enough rel to the shift in fundamentals. We haven't yet talked about ones that have moved too much. Greg, do you have any ideas?

Greg Anderson:

Yeah. I've been searching for those Stephen, and I haven't found much. I guess, I found one that maybe I could argue has moved a bit excessively just in trolling through intra Europe crosses. I found one that it's admittedly kind of an obscure cross for those based in the Americas in Asia, but pretty well known in Europe.

Greg Anderson:

It's [inaudible 00:12:17], or Norwegian krone against the Swedish krona. And normally this cross is pretty quiet and sort of flattish, but since the invasion, [Norky 00:12:30] has gained about 5% against this Swedish. And just today, this Norky Stocky cross printed a new seven year high.

Greg Anderson:

If we're using the measure I was talking about before, standard deviations of daily returns, the move in Norky Stocky works out to about 11 of those. While in Euro dollar, the moves only been nine. So what do you think Stephen, is this move in Norky Stocky excessive, perhaps a classic FX market overshoot?

Stephen Gallo:

Yeah. Norky Stocky is an interesting one, Greg, but I think it's a little bit difficult to draw a firm conclusion. I mean, if energy prices have structurally reached set to higher levels because of supply side issues, and in the long run permanently reduce supply, then I think it makes sense that Norky Stocky has broken its down trend from the last decade, which of course was a difficult one for energy prices, particularly oil.

Stephen Gallo:

So I can say with a lot of confidence that there is a significant degree of overshoot in Norky Stocky. But I do think you can make the case that the Swedish krona has underperformed the Euro too much. And that the near term is likely to see a bit of consolidation in the [Stocky 00:13:47] and a moderate rebound in the Stocky versus the Euro.

Stephen Gallo:

In terms of the difficulties facing the manufacturing sectors in Europe, Sweden, to me, doesn't stand out as being particularly different to Germany or the Euro. And it's going to struggle, I think, to achieve merchandise trade surpluses for some time to come. But in terms of its dependency on energy imports, Sweden, you could argue is actually in a moderately less vulnerable position than the Euro and Germany. So there is probably some room for the Stocky to close the gap with the Euro a bit.

Greg Anderson:

As we wrap up this podcast, I just want to say, I feel a bit empty for just dryly talking about FX markets, given the deadly seriousness of the situation in Ukraine. But the reality is we've just been given this platform to point out risks and opportunities in the Forex market. Simply put, that is our job and it is all we can do, while we hope and pray for a rapid resolution to this conflict without further loss of life and livelihoods.

Stephen Gallo:

Of course, Greg, I would echo that entirely. I don't have a lot of conviction that a major deescalation is upon us, but it would of course be the better of the two scenarios. Let's wrap up things here. Until next week and episode 36, bye for now.

Greg Anderson:

Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at bmocm.com/globalexchanges.

Stephen Gallo:

We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:

This show and resources are supported by our team here at BMO, including the FICC Macro Strategy group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:

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Greg Anderson Chef mondial, Stratégie de change
Stephen Gallo Chef de la stratégie de change pour l’Europe

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