Any further strength in the dollar in the coming weeks and perhaps months should be concentrated against the euro, for it is clear that it is here that the impact of the conflict in Ukraine will fall most heavily.

While there is undoubtedly a good deal of focus on monetary policy, it is likely that rate hikes take second billing behind the war in Ukraine. Mr. Steve Barrow, Head of Standard Bank G10 Strategy, believes that the conflict has the scope to push the dollar higher still, particularly against the euro, but only on a short-term basis, not over the long haul. More of the financial implications of the conflict could come to light this week. Russia is scheduled to make a USD117 million interest payment on Wednesday, but sanctions suggest that it might not be able to pay this in dollars, only roubles.

At least from a Russian perspective, there may be some controversy over whether this means a default, but it could still be an event that escalates uncertainties. Some in the market might remember back to the last time Russia defaulted in 1998, although this was on domestic debt, not international obligations. Back then, the default contributed to significant financial duress amongst creditors, not least Long Term Capital Management (LTCM), which had to be rescued. It led to widespread financial strain, and the question today is whether similar tensions could emerge should Russia default.

The IMF, for instance, argued over the weekend that default is not improbable but won’t have destructive properties outside of Russia. Mr. Steve Barrow prefers to reserve judgement on this one and, as such, would retain a positive bias for the dollar as long as the possibility of adverse contagion effects does exist. The fact that the Fed seems almost certain to lift policy rates this Wednesday, for the first time in this cycle, could also add to the vulnerability among investors should asset prices slip as a result.

"Any further strength in the dollar in the coming weeks and perhaps months should be concentrated against the euro, for it is clear that it is here that the impact of the conflict in Ukraine will fall most heavily. Hence, we still look for the euro/dollar to dip below the 1.05 level, although we do also believe that a slide through parity is unlikely unless the conflict takes a material turn for the worse via Russian attacks outside of Ukraine or if Russia cuts off European gas supplies. So far, there do not appear to be signs that credit tensions are provoking undue demand for dollars, with cross-currency basis spreads, for instance, still stable. In addition, we are not seeing heightened demand for dollars from foreign central banks via swaps with the Fed. This leaves us reasonably confident that dollar strength, while continuing for now, will be contained and won’t necessarily persist into the long haul. So, while we have pulled our euro/dollar forecasts down on a 1-2-year horizon, they still show a material rise from the lows of just below 1.05 that we expect in the short-term. For instance, our 2-year forecast has come down from the 1.40 region that we were predicting before the conflict but is still some way above current levels at 1.25", Mr. Steve Barrow said.

It is a similar story when we come to the pound, for, in the UK too, the negative consequences of the Russia/Ukraine conflict will be felt more heavily than in the US. Even if the war were to end tomorrow, there would still be significant costs for the UK economy as a result of the surge in energy prices. And even though these prices will likely reverse should the conflict end soon, there are still many more permanent effects, such as the decision to switch energy supplies away from Russia, which could prove costly. There is also the danger that much of the inflationary pressure created by the surge in energy prices will stick, forcing the BoE to tighten policy even more. This Thursday should see another rate hike; the third in a row. But Mr. Steve Barrow doubts that this is going to be of much help to the pound against the dollar, and he still envisages a slide to the 1.25 region in the coming weeks and months as the conflict drags on and the UK economy starts to suffer. Thereafter, he sees recovery, but, like the euro, he has adjusted its longer-term forecasts because the Russia/Ukraine conflict is an asymmetric shock that will weigh more heavily on Europe than the US. Hence, its 2- year sterling/dollar forecast is still above the current rate at 1.50-plus but not at the 1.60-plus we had seen before the conflict.