The Russia-Ukraine crisis has created some global shocks.

"Riskier" G10 currencies such as the Australian and New Zealand dollars have performed well, even against currencies deemed to be "safe" like the dollar and the yen. Why is this, and does it tell us anything about the longer-term outlook for currencies?

The Russia-Ukraine crisis has created two types of global shock. The first is an adverse terms of trade shock because the price of food and energy has risen and may well increase much further. The second shock is what we might call one of soaring risk aversion, whereby financial market panic causes slumping equities, surging credit spreads, funding stress, and more. For major commodity producing countries, these shocks may counterbalance one another when it comes to their currency. In other words, the currency benefits of a positive terms of trade shock for net commodity exporters are offset by higher risk aversion, which traditionally depresses such currencies.

We don’t always know which one will dominate, and hence whether the commodity-heavy currency in question will rise or fall. Mr. Steve Barrow, Head of Standard Bank G10 Strategy said his own inclination would actually be to argue that surging risk aversion will dominate rising food and energy prices, and produce currency weakness. But that’s not happened. Commodity-dependency among G10 currencies has actually been associated with currency strength so far, not weakness.

If we go back to the Aussie/Yen cross, for instance, we’d note that Australia’s commodity export revenues are more than three times the country’s commodity import pay-out. In Japan, it is the other way around, with commodity import costs of about six times the revenue from commodity exports. But the Aussie is deemed a "risk" currency as it usually falls heavily when global risk aversion increases, while the yen is seen as a ‘safe’ currency. Hence, we can see the two offsetting forces here and, in fact, when you look at the Aussie/Yen cross, you see broad stability; not the slump we’ve been used to in the past when risk aversion has increased.

The same can be said for the Aussie against the dollar, or for other commodity-related G10 currencies such as the Norwegian krone (where commodity exports are four times more than imports), or the Canadian dollar (over two times). These currencies too have held their own; something that is quite notable for the Norwegian krone, as the currency can really suffer from poor liquidity in times of crisis, as we saw in the early throes of the pandemic. Of course, what’s happened to date since the Russian attact is not a guarantee that it will persist into the long haul, but, if it does, what does it say about issues such as the outlook for commodity prices or, perhaps more fundamentally, the safety of ‘safe’ currencies?

USD has been in uptrend amid the Russia-Ukraine crisis

Mr. Steve Barrow would suggest that it says more about the latter than the former, although he notes that the strength in these commodity currencies could reflect the fact that investors see this commodity price strength persisting for some time and possibly gaining much more traction. As for the "safe" currencies, he has had doubts about the dollar for some time. For one, the dollar's reaction to prior risk-off events more recently, such as the pandemic, seems to show more modest and short-lived bouts of dollar strength.

The Fed's efforts to supply dollar liquidity through times of crisis could be contributing to a more limit ed dollar reaction—and the response of other safe currencies such as the yen. So, all in all, we don’t see this strength of commodity currencies as an anomaly. This does not mean that we rule out any chance of retracement, and perhaps even a big slide, if risk aversion rises much more dramatically. But recent events do leave us feeling a bit more confident that the longer-term direction of safe currencies such as the dollar is likely to be lower, even if we doubt that such trends are going to start in the very near-term as long as the fighting in Ukraine continues.