Russia-Ukraine crisis produces higher inflation, lower growth and “riskier” financial asset prices such as equities and corporate credit should move accordingly.

Russia-Ukraine crisis produces higher inflation, lower growth and “riskier” financial asset prices such as equities and corporate credit should move accordingly. For “safe” government bonds, the juxtaposition of higher inflation and lower growth make things trickier, but it is right that yields have generally risen. The position of currencies too is more complicated. For while there’s the threat of significant weakness in riskier currencies and strength in safe currencies, there’s also the terms of trade differences to bear in mind. For instance, most safe currencies will see adverse terms of trade effects given the surge in energy and metals prices. This can weigh on the value of these safe currencies.

In contrast, many riskier currencies have seen very positive terms of trade effects given their net commodity-exporting status, and this should result in currency appreciation. So far, it has been these terms of trade effects that seem to have dominated. As a result, many commodity-related currencies have risen not just against those safe currencies that face significant adverse terms of trade effects, but also against other non-safe currencies that have experienced bad terms of trade outcomes. The danger going forward, in our view, is that these terms of trade benefits wane and rising risk aversion could yet pull these commodity-related currencies back.

So far, we have spoken in generic terms about safe currencies and those riskier currencies that might expect to enjoy positive terms of trade effects from the Russia/Ukraine conflict. More specifically, the safe currencies that seem most entangled in this web between safety on one side and adverse terms of trade effects on the other, seem to be led by the yen, while the euro and Swiss franc seem slightly better positioned, leaving the dollar the best placed of the lot given its relatively low dependency on energy imports.

On the flip side, Mr. Steve Barrow, Head of Standard Bank G10 Strategy’s view, the riskier G10 currencies that appear to have benefited the most from positive terms of trade effects include the likes of the Australian dollar, Norwegian krone and Canadian dollar. In effect, what has happened if we look at a cross rate such as Aussie/kiwi is that investors seem to have focussed more on the positive terms of trade effects for the aussie/yen cross than the risk-off bias generated by the Russia/Ukraine conflict. In some ways, he is surprised by this.

For while we would look for these terms of trade effects to be the most dominant over the long haul, we might have expected safe currencies such as the yen and the dollar to appreciate a bit more against riskier currencies early on in the conflict and perhaps especially as many other risk assets, such as stocks softened significantly. But can we have any comfort in the fact that these terms of trade effects seem to have outweighed safe asset considerations?

Mr. Steve Barrow said, for a start, while there might be a certain longevity to the rise we have seen in commodity prices, it does look as if the bulk of the really sharp rally in commodities, and hence rapid improvement in the terms of trade of commodity producing countries, is behind us rather than in front of us.

Secondly, the adverse effects of this terms of trade shock for many countries have yet to be fully felt. Central banks will likely push ahead with more and faster tightening to combat inflation, and recessionary risks will surely grow. “These factors create the possibility of a much deeper and protracted slide in riskier assets like stocks and corporate credit and these risk-off effects will likely dominate whatever positive terms of trade effects are still left. In other words, the currencies that have been the ‘winners’ from this Russia/Ukraine shock so far may still turn out to be the losers in the future”, Mr. Steve Barrow stressed.