The price action in the foreign exchange market today is a perfect example of how politics can have a larger influence on short term FX flows than economics. Today’s U.S. economic reports will take backseat to the escalating tensions in the Ukraine. Our colleague Boris Schlossberg wrote a detailed note on the evolving the situation in the region and its implications for currencies. While we are by no means geopolitical experts, it is no secret that the Ukraine is just as important to Europe as it is to Russia. Ukraine is one of the world’s largest exporters of corn and wheat and if those supplies are halted, commodity prices could soar. Russia also supplies a quarter of Europe’s oil, half of which is pumped via pipelines running through the Ukraine and if the conflict leads to an energy supply shock, oil prices would rise. Although stiff sanctions seem to be the most likely consequence of Russia’s actions, military action remains a possibility. Lets not forget that under the Budapest Memorandum signed in 1994, the Ukraine agreed to give up its arsenal of nuclear weapons in exchange for “security assurances” from the U.S. and U.K. if their territorial integrity becomes threatened. Any sign of potential military action by Western Nations would cause more risk aversion in the forex market because investors rarely view the prospect of war as positive especially when it involves major world powers like the U.S. and Russia.
Even without the growing turmoil in the Ukraine, this is a busy week in the foreign exchange market and we are already beginning to see volatility increase in certain currency pairs such as USD/JPY. We have 4 major central banks making monetary policy announcements (RBA, BoC, ECB and BoE), PMIs from the U.K. and Australia along with employment reports from the U.S. and Canada. China will also kick off the National People’s Congress (NPC), the annual 9 day meeting in which more than 3,000 delegates will convene to approve laws, policies and the budget. For the financial markets, the focus will be on the government’s growth targets, which will be shared by Premier Li Keqiang on Wednesday.
As a safe haven currency, the dollar will be particularly active this week. Increased tensions in the Ukraine could boost demand for the greenback, putting pressure on the EUR/USD. However if Russia/Ukraine/Western Nations magically reach a diplomatic solution, investors will rejoice by sending EUR/USD to fresh yearly highs. Non-farm payrolls are also scheduled for release this week and while the report is not due until Friday, other labor market reports will help to shape expectations for Friday’s release. After 2 months of subpar job growth, the U.S. economy desperately needs to create more jobs to keep the Fed on track to reduce asset purchases by another $10 billion in March. If fewer than 110k jobs were created this month, not only does Janet Yellen need to drop the unemployment rate threshold, but she may be forced to seriously consider a smaller amount of tapering. We would be surprised if the storms in February did not affect payrolls but a reading below 110k would be hard for the Fed and investors to ignore.