(Bloomberg) -- The euro plunged against the dollar and bonds rallied after Russian President Vladimir Putin threatened to escalate his war in Ukraine, sending investors scurrying to haven assets ahead of an expected jumbo rate hike by the Federal Reserve later Wednesday.
The common currency fell as much as 0.9% to $0.9885, a two-week low, after Putin announced a “partial mobilization” and vowed to use all means necessary to defend Russian territory as the Kremlin moved to annex parts of Ukraine that it’s occupied. German bonds rebounded across the curve, outperforming Treasuries.
The prospect of a renewed push from Russia deals another blow to Europe, already on the brink of recession as it grapples with an energy crisis. It’s likely to keep weighing on the single currency, which is down almost 13% against the greenback this year. An expected three-quarter point rate hike from the Federal Reserve threatens to sap risk appetite further.
Wednesday’s headlines “suggest we may be on the brink of an escalation of the war, which raises a whole new set of uncertainties,” said Rabobank strategist Jane Foley. The euro traded at $0.9903 as of 10 a.m. London.
One-day volatility in euro-dollar rallied toward 25% in a sign of the uncertainty sweeping through markets, while the Bloomberg dollar spot index rose to a new all-time high. The pound fell as much as 0.7% to $1.1305, a fresh 37-year low.
Bund yields fell more than 7 basis points to 1.85%. Gilts were rallying alongside German bonds, led by the long end.
Fed focus
Still, expectations of a jumbo rate hike in the US seemed to put a cap on gains. Money markets are fully pricing a third straight 75 basis-point increase, taking interest rates to the highest level since 2008, after stronger-than-expected US inflation data last week dashed speculation that cost pressures had peaked.
“Putin’s talk of partial mobilization and defending territory does not seem inflammatory enough to take much attention away from the Fed,” said Peter McCallum, a rates strategist at Mizuho International. “Markets are used to looking through nuclear hints by now.”
Treasury yields were 3 to 4 basis points lower across the curve, but remain close to the highest levels seen in this hiking cycle. Two-year Treasury yields, trading around 3.94% on Wednesday, are poised to crack above 4% for the first time since 2007.
Flatter curves
European natural gas prices rose as traders assessed the security of winter supply, even as nations deepened efforts to prevent the energy crisis from snowballing. European Central Bank President Christine Lagarde said Tuesday that further hikes will follow, even after the “major steps” already taken to tackle record inflation of 9.1%.
Read more: Lagarde Sees More ECB Interest-Rate Hikes After ‘Frontloading’
“The way you would expect this to play out is through more curve flattening as the long-end is more free to price geopolitical risks, while the front-end is kept higher by hawkish central banks,” said Antoine Bouvet, a rates strategist at ING Bank NV.
Credit risk across Europe was higher on Wednesday. The cost of insuring against investment-grade and junk-rated debt rose, with both gauges nearing two-year highs, according to data compiled by Bloomberg.