Ukraine, Crimea and the dollar safe-haven bid

A week that saw a nine per cent fall in copper, a Chinese corporate credit default, talk of financial sanctions on Russia to punish Putin for Crimea, panic selling on Wall Street saw no safe haven bid in the US dollar against the euro, though the Japanese yen and Swiss franc rose.

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Published: Mon 17 Mar 2014, 10:11 AM

Last updated: Fri 3 Apr 2015, 5:55 PM

I am actually surprised by the mildness of the risk aversion trade given the sheer scale and significance of China’s credit distress and potential Russian invasion of eastern Ukraine.

The commodities currencies have begun to respond to the “China fear”, as the fall in the Aussie, Kiwi’s, Norwegian Kroner (Nokky to the forex cognoscenti!) Malaysian ringgit and Russian rouble demonstrate. Chinese macroeconomic data is ominously soft and its financial sector is under severe stress as its President consolidates power in the Politburo and the provincial Communist Party governments. China’s first onshore corporate bond default could mean its “Lehman moment” in international finance and the unwinding of a credit bubble that makes US subprime look like a Sunday school picnic. Could this mean another spike in the yen?

Are these macro risks priced into exchange rates? Absolutely not. Planet Forex is fixated on the Bank of Japan, ECB and the Bank of England, who are all on hold. I believe the ideal strategy in this milieu is to short the Canadian dollar, since it is sensitive to global growth, China, risk aversion and metals/ oil. The Bank of Canada has a bias to ease monetary policy given its minimal inflation rate and stratospheric consumer debt. I see 1.12 as my next short-term target. I am stunned to see the euro above 1.39 even as Martin Wolf argues in the Financial Times that the eurozone is one negative shock away from deflation.

This could well happen if sanctions on Russia lead to mayhem in the banking and energy markets. Will Mario Draghi be remembered as the ECB Chairman who did nothing while the Old World sleep walked into deflation? Martin Wolf recommends the ECB announce a two per cent inflation target, implement QE, announce LTRO and even negative deposit rates. If his macro scenario and ECB response is true, a major fall in the euro could result. I find it entirely significant that the yield on the ten year German Bund has fallen more than the yield on the ten year US Treasury note. In any case, I believe a rise in currency volatility is now inevitable. At any rate, euro dollar is now a sell above 1.39 for a 1.36 initial target.

Russia now risks its international financial markets access with the Kremlin’s decision to amass armoured divisions and artillery units in Rostov, Kursk and Belgorod. This means the risk of a Russian-Ukraine war after the Crimea referendum is all too real, despite Secretary Kerry’s diplomatic talks with the Russian Foreign Minister in London. Even though Russian shares have lost 20 per cent in the past two months and the rouble has fallen to 2008 lows against the dollar, another bloodbath will result if the West imposes financial sanctions on Russia. The Ukraine/Crimea crisis has pushed gold to six month highs. Goldman Sachs estimates $50 billion in flight capital has fled Russia. Russian state owned banks are saddled with $30 billion in loans to Belarus and Ukraine and would be devastated by financial sanctions German banks/ markets re most vulnerable to Russian sanctions as Germany is the Kremlin’s largest trading partner. The safe haven bid in King Dollar will continue.

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