Global currencies were broadly volatile on Tuesday as foreign exchange traders bid higher on the effects of increasingly widespread supply-side inflation shocks in the wake of the Iran war.
The U.S. dollar index (DX-Y.NYB) rose more than 1% in early trade, while the euro fell nearly 1% against the greenback and sterling slid about 0.8%. The dollar also gained nearly 0.8% against the Swiss franc and strengthened slightly against the Japanese yen and Chinese yuan.
The dollar is gaining not only against the index but against a basket of other currencies as the market assesses that the US is facing a direct physical supply disruption, though not an exemption.
The moves suggest that markets are moving away from the traditional risk-averse regime — where bonds, safe-haven currencies, and gold are expected — and toward assets that perform in a higher interest rate environment.
“Negative supply shocks and risks to growth” should dominate global income restructuring driven by the war, and therefore how currencies perform, economists at Goldman Sachs said in a recent client note.
For currency markets, an increase in energy costs represents the potential terms of trade, or a sudden change in the price of exports relative to imports. This can result in rising import bills, widening the trade deficit, and reducing real incomes. The move could put pressure on the currency even as domestic bond yields rise.
Amid long-term supply shocks, oil-importing economies such as Europe and Japan are likely to see weaker currencies, while energy exporters such as Canada, Brazil, and Norway may experience relatively better FX performance, Macquarie FX and pricing strategist Thierry Wizman wrote in a recent client note.
“The potential ‘winners’ in a protracted war would be the oil importers, while “the currency boosters would be the countries with the largest oil reserves and capacity,” Weisman wrote.
Indeed, the euro edged lower despite a sharp move in European yields, with UK, French, and Italian benchmark rates rising more than 10 basis points through the session. Traders sharply cut bets on a near-term rate cut from the Bank of England, while expectations for European Central Bank easing also eased.
But higher yields did not provide support to the euro or sterling, underscoring investor concerns that continued energy disruptions will further undermine growth prospects and strengthen the credibility of monetary policy.
Emerging market currencies tied to energy imports are also under pressure, as their central banks have little flexibility to “investigate” energy-driven inflation with a higher weighting of oil in the consumer price index and a weaker anchoring of expectations, potentially limiting rate cuts in oil-importing economies, according to Goldman Sachs economists.
Goldman Sachs
