Energy price shock driving FX market performance

USD: Negative energy price fallout hitting European FX performance

The US dollar has continued to strengthen in response to the conflict in the Middle East. It has helped to lift the dollar index back above technical resistance from the 200-day moving average at around 98.360. It has reversed all of the losses from earlier this year. The European currencies of the Swedish krona, Swiss franc and euro have weakened the most against the US dollar since the end of last week reflecting concerns among market participants that European economies would be hit harder by another energy price shock. Those fears have been reinforced by the ~70% jump in the price of natural gas in Europe. Gas prices jumped after Qatar shut LNG production at the world’s largest export facility after it was targeted in an Iranian drone attack. QatarEnergy’s Ras Laffan plant covers about a fifth of global liquefied natural gas supply. QatarEnergy has declared force majeure, a clause that allows it to miss contracted deliveries of LNG to customers without a penalty due to events beyond its control. LNG shipments from the Middle East had already been disrupted since the weekend as tankers largely stopped transiting the Strati of Hormuz. Bloomberg noted that Asian countries buy most of the LNG  shipped from the Middle East, but disruption will increase competition for alternative supplies pushing up prices globally. At the same time, European gas inventories are unusually low which will require large volumes of imports this summer to refill tanks before next winter.

We have significantly revised lower our forecasts for European currencies against the US dollar in our latest monthly FX Outlook report (click here) released yesterday. We have made the assumption that the bulk of the negative impact on European currencies will occur this month before fading as the year progresses. It follows comments from President Trump that US military action in Iran could last for four to five weeks or so. A more protracted conflict and/or much greater disruption to global energy supply would further increase downside risks to our forecasts for weaker European currencies against the US dollar.

Even the Swiss franc which normally benefits from a pick-up in safe haven demand triggered by geopolitical and global inflation risks has weakened. The Swiss franc attempted to strengthen initially yesterday but quickly gave back those gains after the SNB sent a strong signal that they were moving closer to intervening in the foreign exchange market to dampen currency strength. The SNB stated that “in  view of international developments, we are increasingly prepared to intervene in the foreign exchange market. We are ready to intervene in the foreign exchange market to curb a rapid and excessive appreciation of the Swiss franc, which would jeopardize price stability in Switzerland”.  The statement helped to lift EUR/CHF back above the 0.9100-level after it hit a low yesterday at 0.9025. The verbal intervention from the SNB indicates as well that they would prefer to intervene if necessary to dampen currency strengthen rather than lower rates back into negative territory. The Swiss rate market is still pricing in only a small probability of a return to negative rates ahead of the SNB’s upcoming policy meeting on 19^th March.

On the other hand, the G10 commodity currencies of the Canadian dollar and Australian dollar are holding up better against the US dollar. The Australian dollar has derived support from hawkish comments overnight from RBA Governor Bullock. She stated that “every meeting is live” in response to a question on whether the RBA was only adjusting rates on a quarterly basis and a March move could be discounted. It has encouraged Australian rate market participants to bring forward expectations for a second rate hike at the start of this year. She stated that “we have inflation at 3.8% and the board will be actively looking at whether or not it needs to move more quickly. So I would discourage people from thinking that we necessarily only need to move quarterly”. She added as well that the RBA is “very alert” to potential implications for inflation expectations from the Middle East conflict and is “well postponed” for a policy response if required. With the RBA already concerned over the risk of higher inflation proving more persistent in Australia, the jump in energy prices could encourage the RBA to pull the trigger on further rate hikes at the start of this year. Higher yields are helping to support the Aussie but it could come under more selling pressure if higher energy prices eventually trigger a bigger correction lower for risk assets.

FX IMPACT OF ENERGY SHOCK IN 2022 TRIGGERED BY UKRAINE CONFLICT

Source: Bloomberg, Macrobond & MUFG GMR

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com