US dollar has risen strongly vs Russian Ruble. Photo a worker checks Russian ruble banknotes at a Moscow-based printing factory. 

These obviously include the news-flow on the state of the conflict, new sanctions, peace efforts, the movement in energy prices and much more. But what should we watch the most closely, especially if we want to see if the conflict starts to infect risk assets in a big and potentially dangerous way?

There are a number of indicators that we’d watch particularly closely at this point. The first is access to and the cost of acquiring dollars. Crisis events such as war can spur significant demand for dollars. Should this lead to any sort of dollar shortage problem, the greenback could really surge and countries that might struggle with their access to dollars even during more normal times could find themselves under particular pressure. How do we measure such pressure?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy said in an international context, he likes to use basis spreads, which is the cost of securing dollars through the FX market. In times of stress, funding dollars through the interbank market may become challenging or expensive, and hence borrowers may turn to the FX market. If they do so in sufficient size, this can push basis spreads significantly and clearly suggest that dollar funding conditions are tightening. Basis spreads are priced in various currencies, but the one to watch out for is the euro/dollar basis, just as the euro/dollar spot rate is the most closely watched. Right now, pressures are developing here. So far, these pressures are far short of what we’ve seen during other periods of tension, such as the initial COVID wave in early 2020, but basis swaps bear watching closely.

Given that factors such as sanctions against Russian banks, Swift expulsion, and an asset freeze on the central bank could contribute to missed-payments to international creditors, it is also important to watch how pressures develop on banking systems outside of Russia. In the US, the TED spread, the difference between the rate on eurodollars and treasury bills, is a common gauge for such funding strains. Again, pressures here have risen as well, although they still remain modest on an historical basis. Of more interest, perhaps, is the equivalent measure for the euro zone, as it is banks here that have the biggest loan exposure to Russia, particularly Italy, Spain, and Austria.

Outside of market prices such as these, we’d also look out for any dollar supply coming through from the Fed via central bank swaps and repos. For example, if other countries' central banks detect a potential dollar shortage, they will use swap and/or repo arrangements with the Fed to acquire dollars on a temporary basis.If the use of these facilities increases substantially, then it may be another sign that dollar liquidity conditions are becoming tight even if that’s not necessarily reflected in market prices, such as basis spreads.

On a more general note, Mr. Steve Barrow would also watch indicators that try to track financial conditions in the US as reflected in some of the indicators we have already mentioned and more besides, such as credit spreads, asset price volatility, and more. The importance of significant tightening here is that it could persuade the Fed (or other central banks that see similar financial tightening at home) to scale back the degree of tightening that they are likely to push through via rate hikes and quantitative tightening. One such measure is the Chicago Fed's financial conditions index. "Like the other indicators we’ve spoken about, there are definitely stirrings of pressure, but, in our view, we would have to see such indications tighten up a lot more to obviate the Fed’s need for significant rate increases," Mr. Steve Barrow said.