Twenty million metric tons of wheat and corn remains blocked by Russia in Odesa, the port city of Ukraine. Soon after negotiating a deal with the United Nations allowing for removal of the blockade on Ukrainian grain exports, Russia immediately turned its back on the deal, by bombing the city of Odesa. The US agency for international development (USAID) administrator, Samantha Power told CNN correspondent Larry Madowo that the US is working on a contingency plan for Ukrainian grain exports. “You cannot trust anything Vladimir Putin says,” says USAID boss. The alternatives available include adjusting Ukraine’s rail system to ensure that it is better linked with Europe. As there appears to be no alternative for the efficient way to move grain out of Ukraine through the black sea, food prices will remain elevated. Urgent collaborative action on international level is required in order to prevent the current food crises turning into a catastrophe. Countries like Ethiopia, Kenya, and Somalia which are in the horn of Africa, a region which have experienced the worst droughts on record might face massive starvation and deaths.
It has been more than four months now since Russia invaded Ukraine. One wonders if Ukraine is the pawn in chess being used by NATO in its own fight with Russia, while from a distance, the US stood and watch fearlessly like the untold power hungry, king of the West. Being so cunning and rather deceitful, Putin appears more like the modern day emperor of the ancient Roman times, decorated with ferocious warriors (nuclear weapons). Of course, it is bigger than a game of chess! As the war rages, major currencies face a sharp depreciation against the US dollar. The Chinese yuan, euro, Japanese yen and the pound sterling are among the most affected currencies.
Same as gold, the US dollar is safe haven hence makes it an attractive store of value in times of uncertainty or crisis like the war in Europe has triggered market participants to preserve their wealth in the American greenback. Earlier, the delay in hiking interest rates by the Federal Reserve Bank of the US following the invasion of Ukraine by Russia on the 24th of February early this year has seen a drastic increase in the value of gold in US dollar terms, nearly challenging the all-time high of US$2074 per ounce. The Gold-US dollar trend has seen an imminent reversal following aggressive interest rate hike by the Federal Reserve. As a result, gold has tested the USD1680 per ounce, the level of which it last reached almost a year ago in August 2021. The interest rate is a fundamental determinant of a country’s exchange rate. The abrupt reversal of the gold-US dollar trend has confirmed beyond reasonable doubt. The Federal Reserve will remain aggressive in its monetary as long as inflationary pressures due to demand being greater than supply in the economy persist or at least if core inflation continue to trend upwards.
Of course, the Euro wins the proximity advantage when discussing the war in Europe. The notion resonates well with the heads of forex at Goldman Sachs’ expectation on the Euro whom by March anticipated a sustained appreciation of the currency. So far, the Euro has seen an enormous depreciation against the US dollar since the war started, hence signifying the attractiveness of the US dollar as a safe haven asset. The euro has gone down 12% against the US dollar since the beginning of the year. The Euro has always held a higher value compared to the US dollar and it is only since the invasion of Ukraine by Russia that we are seeing the US dollar coming closer and closer to an equal worth with the Euro. The last time the two currencies were in parity was in 2002. As the war continues, it is likely that the Euro will weaken against the US dollar given that the Federal Reserve is more aggressive with its monetary policy tightening.
The depreciation of the Euro against the US dollar hurts Euro Zone member countries who used to rely more on Russian energy products. Due to the sanctions on the Russian economy, they now face mounting import bills since some of the significant imports like crude oil are priced in US dollars. Currency depreciation is also fueling inflation. Before the war, the European Union consumed about 40 percent of its gas via the Russian pipelines. The Eurozone faces high uncertainty and the risk of even higher inflation and a recession since Russia has cut back gas supplies and recently, it has cut by 40 percent, the flow in the Nord Stream pipeline to German.
The difference between the Fed and the ECB monetary policy approach stems from the fact that the US economy experiences maximum employment since its latest unemployment reading has reached the record level of 3.6 percent. More so, the recent positive yields on U.S. makes investors believe that the Fed is capable of lowering inflation while maintaining a strong economy since the increase in yields outweighs inflation expectations. On the other hand, the story is different for the Eurozone. The latest unemployment rate for the euro area is already high at 6.8 percent. Interest rate hikes will result in even higher unemployment rate and major negative impact on economic growth. On July 21, the council has decided to raise the ECB’s key interest rates. From July 27, the interest rate on the main refinancing operations as well as the interest rates on the marginal lending facility and the deposit facility will be raised to 0.50 percent, 0.75 percent and 0.00% respectively.
Asian major currencies (Japanese yen and the Chinese yuan) also weakened against the stronger dollar mainly due to accommodative monetary policy stance in the respective economies and the fact that China and Japan are among the biggest importers of energy in the world. Ever since the conflict between Russian and Ukraine broke out in March, the Chinese yuan has reversed its persistent strong appreciation trend against the US dollar. Both onshore and offshore yuan broke the 6.55 per US dollar, reaching their lowest level since April 2021. In a positive sense, the depreciation of the yuan could help stimulate Chinese exports given a near contraction of the country’s economy. Both the manufacturing and service sectors have been seriously impacted by the pandemic control policies in China. The Governor of the People’s Bank of China (PBoC), Yi Gang has pointed out the need to stimulate the economy since inflation is moderate in China and is expected to remain low. However, it is pretty likely that the PBoC’s accommodative monetary policy is mainly targeted at lowering required reserve rations than interest rates. This is taking into consideration that widening Treasury bond yields between China and the US will trigger massive financial outflows of which may result in wild depreciation of the Chinese Yuan. Hence there is need for the PBoC to ensure that the margin of safety in terms of the interest rate gap between the two economies is maintained. Similarly, in Japan, inflation remains low despite the weakening yen. Further, Japan’s economy is experiencing a negative employment and output gap. Therefore, the depreciation of the yen might help stimulate the economy through export growth, disregarding the impact of softening global demand. The Bank of Japan also remains accommodative with its monetary policy which has resulted in lower interest rates compared to those in the US.
Even though Russia accounts for only 5 % of UK’s imports, the spill-over effect of the war has triggered the pound’s depreciation. During the early stages of the Russia-Ukraine war, the pound has weakened to its lowest point since December 2020. The UK is a net importer of fuel and food. As a result, rising commodity prices significantly contributes toward depreciation of the pound. However, the weakening of the pound against the US dollar is somewhat due to the Bank of England’s less aggressive monetary policy stance in terms of interest rate hikes. Even though both economies are facing a tight labor market situation, the most recent interest rate decisions has seen the Bank of England making an interest rate hike of 50 basis points meanwhile the Federal Reserve Bank of America hiking by 75 basis points.
Squarely, the interest rate has fundamentally contributed to the depreciation of the other major currencies against the US dollar. Unfortunately, depreciation of currencies might not stimulate economies through export growth due to softening global demand and supply constraints but fuel inflation. As it stands, the interest rate shall remain fundamental in influencing the foreign exchange rate. Judging on the current economic outlook, monetary policy has to balance between exchange rate, inflation, unemployment and economic growth. Provided that the Federal Reserve of Bank of America maintains a more aggressive monetary policy stance, a handful of major currencies will continue weakening against the US dollar.
