What a Russia–Ukraine conflict could mean for the forex market
12:00, 1 June 2022
The deepening of the geopolitical conflict between Russia and Western countries over the destiny of Ukraine has resulted in significant shocks across multiple asset classes, including currencies in the forex market.
With the rise in the price of energy commodities on the one hand and the declaration of economic sanctions on the other, investors are struggling to predict forex market spillovers from the crisis.
By examining trade ties, macroeconomic fundamentals and historical precedents, we explore what the Russia–Ukraine dispute may mean for the Russian ruble (RUB), the euro (EUR), the US dollar (USD) and other currencies affected by geopolitical developments.
Rising energy prices fuelled RUB and commodity currency gains in 2021
Before looking closely at how different currencies may react to the geopolitical conflict between Russia and Ukraine, it is necessary to take a step back to understand the current situation in the energy market and its implications for the forex market.
Russia is one of the world’s leading producers and exporters of oil and natural gas. It produced an estimated 10.5 million barrels per day (b/d) of liquid fuels in 2020, ranking behind Saudi Arabia and US, and was the world’s second-largest producer of natural gas after the US, with an estimated 22.5 trillion cubic feet, according to EIA.
Energy consumption in neighbouring regions, such as Europe, is heavily reliant on Russian supplies: Russia is the principal supplier of natural gas to the European Union (EU), accounting for more than 40% of its gas consumption.
Over the past winter, Europe has experienced an unprecedented energy crisis as the escalating tensions in Ukraine and the German regulator’s rejection of the Nord Stream 2 project prompted Russia to restrict gas transit via the Ukrainian channel, driving the European natural gas benchmark (the Dutch Title Transfer Facility [TTF]) to an all-time high of €180 per megawatt hour (MWh) in mid-December 2021.
The geopolitical tensions between Russia and Ukraine have also marginally affected the rise in world crude-oil prices, although a main spark of the 2021 oil rally was the post-pandemic inability of supply to adjust to a strong recovery in demand.
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Commodity-linked currencies outperformed commodity-importers’ currencies in 2021
The dramatic price increases in oil (+60%), natural gas (+50%) and other energy commodities bolstered performance of the Russian ruble (RUB), as well as other commodity-related currencies in 2021.
These include the Canadian dollar (CAD) and Norwegian krone (NOK), particularly when compared to the currencies of commodity-importing countries such as Japan.
In 2021, the euro lost 7.5% of its value against the Russian ruble (EUR/RUB), 8% against the Canadian dollar (EUR/CAD) and 4.4% against the Norwegian krone (EUR/NOK).
The Japanese yen (JPY) fared worse, weakening by as much as 10.3% versus the ruble (RUB), 10.2% versus the Canadian dollar (CAD) and 7.5% versus the Norwegian krone NOK.
RUB, NOK and CAD outperformed EUR, CHF and JPY in 2021 – Credit: Capital.com / Data: TradingviewGeopolitical risk and sanctions hit RUB in 2022
On 22 February, the US and its allies announced a first round of sanctions on Russia in response to the Russian Parliament’s recognition of two regions of Ukraine (Donetsk and Luhansk) as independent states and authorisation of the deployment of additional Russian troops into breakaway territories for “peace-keeping operations”.
- The US announced sanctions against two large state-owned Russian financial institutions (Vnesheconombank and Promsvyazbank and their subsidiaries) and five Russian individuals, as well as a prohibition on individual US investors and firms from participating in secondary markets covering Russian government debt.
- The EU has announced its intentions of penalising 351 Russian parliamentary members for their recognition of the self-proclaimed People’s Republics of Donetsk and Luhansk, as well as 27 persons and corporations engaged in this activity.
Additionally, the EU will limit the Russian government’s access to EU financial markets and banned trade between the two separatist areas and EU countries, while Germany has suspended the Nord Stream 2 pipeline’s certification process. - The UK government decided to freeze the assets of five Russian banks (Bank Rossiya, the Black Sea Bank for Development and Reconstruction, IS Bank, Genbank and Promsvyazbank) which were implicated in the Ukraine crisis or supporting Russia's defence industry.
It has also imposed travel restrictions on three members of Russia’s elite (Boris and Igor Rotenberg, as well as Russia’s sixth-richest oligarch, Gennady Timchenko). The UK will also penalise Russian Duma and Federation Council members who voted to recognise the independence of separatist republics Donetsk and Luhansk.
The escalation of geopolitical tensions and the recent adoption of economic sanctions against Russia have resulted in a significant depreciation of the Russian ruble, which has substantially decoupled from other commodity-linked currencies since the start of the year.
RUB started to decouple from commodity-linked currencies in 2022
RUB decoupled from CAD and NOK: USD/RUB, USD/CAD and USD/NOK performance year-to-date as of 23 February 2022 – Credit: Capital.com / Source: TradingviewTrade exposure to Russia
Considering the likely impacts on trade from the ongoing crisis, which countries curerntly trade with Russia the most? And which would experience the greatest financial implications from any trade frictions with Russia?
Using data from trademap.org and imf.org, among North Atlantic Treaty Organization (NATO) member states, Slovakia has the highest trade exposure to Russia (6%) (defined as the total of the country’s import and export flows with Russia as a percentage of gross domestic product [GDP]), followed by the Netherlands (5.4%) and Finland (5%).
Including Germany, Italy, Spain and France, the eurozone’s bilateral trade with Russia exceeds 20% of GDP.
It’s worth emphasising that East European, non-euro member countries’ trade exposure to Russia is substantially less: Hungary (4%), Turkey (3.5%), Czech Republic (3.4%) and Poland (3%). The UK and US, on the other hand, have very limited trade relations with Russia.
Bilateral trade (2019) between NATO member states and the Russian Federation – Source: UN COMTRADE ªUnited Nations International Trade Statistics Database) and the International Monetary Fund (IMF); Credit: Capital.comRUB & Central and Eastern Europe (CEE) FX: What happened in 2014
The current confrontation between Russia and Ukraine rekindles memories of the 2014 annexation of Crimea and Sevastopol by Russia that caused Western countries to impose economic sanctions.
In July 2014, the US announced a third round of sanctions on Russian financial sectors and oligarchs, triggering a significant fall of the Russian ruble and other currencies with trade links to Russia in the months that followed.
The USD/RUB exchange rate increased by 97% in the semester after the international sanctions imposed on Russia in July 2014.
Apart from the RUB, the Polish zloty (PLN) had the poorest performance versus the US dollar (with USD/PLN up 23.34%), followed by the Czech koruna (USD/CZK, +21.7%), the Hungarian forint (USD/HUF, +21.43%), the Romanian lei (USD/RON +21%), the euro (USD/EUR, +20.2%) and the Turkish lira (USD/TRY, +12.3%).
| FX pair | % Change (15 July 2014 – 28 January 2015) |
| USD/RUB | +97.04% |
| USD/PLN | +23.34% |
| USD/CZK | +21.7% |
| USD/HUF | +21.43% |
| USD/RON | +21% |
| USD/EUR | +20.2% |
| USD/TRY | +12.3% |
RUB & CEE FX performance between July 2014 and January 2015 – Credit: KoyfinRussia–Ukraine crisis: Will the ruble fare better this time?
In view of historic sanctions parallels with the current situation, is Russia better able to withstand economic sanctions or even avoid a ruble currency crisis because of its macroeconomic fundamentals?
One of the most often asked questions by investors is whether the divergences in underlying factors and macroeconomic fundamentals from 2014 may alter the course of events in the FX market this year.
There is little doubt that Russia enters the current geopolitical crisis in a substantially stronger macroeconomic and financial position than it was in in 2014. It has one of the lowest debt-to-GDP ratios in the world (17%), and its current-account surplus hit a new high of $120.3bn (£86.1bn, €106.37bn) in 2021 (roughly 8% of GDP), up nearly threefold from 2020, as a result of a significant increase in key goods exports thanks to higher global energy prices in oil and gas.
If the price of Brent crude sank from $115 per barrel in the second half of 2014 to approximately $50 per barrel at the end of the year, oil is now hovering around $95 per barrel, up 50% from a year ago and facing increased risks of exceeding $100.
But, most importantly, Russia has the fourth-largest level of foreign currency reserves in the world, behind only China ($3.36trn), Japan ($1.4trn) and Switzerland ($1.08trn).
Foreign currency reserves held by Central Bank of Russia have risen by around 70% since the 2014 crisis, from a low of $355bn to the current all-time highs of $630bn, or 45% of the Russia’s GDP, which may constitute a fortress to rely on in the case of elevated currency instability.
Russia FX reserves are at all-time high
Russia FX reserves – Credit: TradingviewMarkets in this article
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