FX: Impact of US/EU Sanctions, China and US Data

Most of the major currency pairs are trading higher this morning or making their way into positive territory. Foreign exchange investors have nerves of steel today, bidding up euro on the official announcement of sanctions on Russian politicians by the U.S. and EU. The U.S. announced plans to freeze the assets of 11 key Russian and Ukrainian officials and the EU will impose sanctions on 21 members of the Ukrainian and Russian government involved in Moscow's incursion into Crimea. The euro is responding well to these initial measures because they are limited to a small group but today's announcements represent the international community's very first response to Russia's violation of Ukraine's sovereignty and territorial integrity. If Russian troops move into Ukraine, more severe and widespread sanctions are sure to follow. There is very little chance that Russia will bat an eye at these sections. In fact, Putin has threatened his own restrictions, which could be announced in the coming hours or days. So while risk appetite has improved today, under these circumstances, it will be very difficult for the optimism to be sustained because there is a high risk of the crisis in the Ukraine deepening. However, until Russia retaliates investors are buying euros on the relief that the initial sanctions are mild and the currency could aim for fresh 2-year highs.

The aftermath of the referendum in Crimea this weekend is not the only big story in the foreign exchange market. On Saturday, China also doubled its Chinese Yuan trading band. They will now allow the CNY to fluctuate 2% above or below its daily midpoint rate, up from 1%. Given the currency's recent rapid decent, this decision was not a complete surprise and had only a limited impact on major currencies. Nonetheless it represents a major shift in FX policy for the central bank. The PBoC is clearly using the exchange rate as a means to increase stimulus and provide additional support to its economy as growth slows. With exports falling by the largest amount in more than 4 years during the month of February, the economy could certainly use the support of a weaker currency, which helps to make the cost of Chinese imports more competitive. Although the central bank argues that today's move is a step towards increasing exchange rate flexibility and greater two-way volatility in the currency, in the context of falling exports the recent slide in the Yuan clearly reflects an attempt to support the economy. A weaker Yuan hurts countries like Australia and Japan who rely heavily on Chinese demand. However even though trade balances could suffer, the AUD and JPY have taken the band winding in stride. For the U.S., China's announcement impacts the dollar by slowing reserve accumulation. Yet like AUD and JPY, there has been very little reaction in the U.S. dollar.

This morning's U.S. economic reports did not have much impact on the greenback. Manufacturing activity in the NY region increased slightly less than expected in the month of March but concerns about the sector was offset by a strong rise in industrial and manufacturing production along with an increase in capacity utilization. The NAHB housing market index rose, reflecting an improvement in builder confidence but the increase fell short expectations. As long as these reports show an improvement in the economy, it poses very little threat to the dollar ahead of Wednesday's FOMC rate decision.