Buy-side Firms Weigh FX Impact of Russia-Ukraine War
The Russian invasion of Ukraine has upended economic expectations, with major implications for FX. So what will this mean for buy-side firms?
Traders and portfolio managers have always kept abreast of macro views and geopolitical trends. However, the Russia-Ukraine conflict presents unprecedented challenges. A major European land war was not supposed to happen. What’s more, it has brought severe repercussions for Russia. One of the major BRIC nations, an emerging market with vast natural resources, is now virtually untouchable for many western firms.
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Mean reversion
The FX implications have evolved in the short history of the war. According to a J.P. Morgan analysis, it initiated pockets of volatility, with the US dollar/Ruble hitting all-time highs. Moves in the broader FX markets were tame at the point of writing, with euro-area currencies the most exposed, the analysis found.
The bank saw the situation as a catalyst to trigger mean reversion, in which the US dollar, the yen and the Swiss franc would outperform vs high beta currencies. Given the eurozone’s reliance on Russian energy, it warranted increasing short-EUR exposure, J.P. Morgan said.
The implications were not lost on major buy-side firms. Early in the crisis, at the beginning of March, Fidelity International’s emerging market equities portfolio manager Nick Price, pointed to the USD640bn held by Russia in foreign exchange reserves. Because sanctions had made it difficult to intervene in the FX markets, “we are seeing the Ruble move around enormously”, he said, with a leap in interest rates.
Price said his firm’s Russian exposure was being reduced. Likewise, US giants BlackRock and Vanguard said they had suspended the purchase of the country’s securities. The UK’s largest pension fund, USS, said in early March that it had already halved its equity investments related to Russia.
Prospects for peace
While it is too early to predict an end to the conflict, there were some hopeful signs at the end of March, with significant implications for FX. Ukraine and Russia were holding peace talks in Turkey, which boosted both the euro and the Ruble. The latter almost reached the position it held against other currencies before the war commenced.
According to ING, investors are increasingly optimistic: “With not much geopolitical risk premium left, the FX market could start catching up with the recent shifts in rate differentials and economic fundamentals.” In the bank’s view, this implies a stronger dollar, with the potential for the overvalued EUR/USD to slip back below 1.10.
“We think that we are inching closer to a situation where the FX market gradually detaches from trading purely on the back of geopolitical developments in Russia and Ukraine and slowly reconnects with those variables that in the long run drive currency moves: economic fundamentals and rate differentials. And these unmistakably argue in favour of USD strength – EUR/USD weakness,” the bank stated.
For buy-side firms, this isn’t quite a recipe for positivity – but it does provide food for thought.
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