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Ukraine Invasion and Asset Prices

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March 04, 2014 – Comments (0)

Board: Macro Economics

The Russian occupation of Crimea in Ukraine has great geopolitical significance.

As investors, METARs naturally want to know how asset prices may be affected. I hope that this will start a discussion (especially from European METARs) about probable market moves.

Russia itself is keenly aware that the initial reaction of the U.S. sanction activity is likely to be financial rather than military.


http://www.cbr.ru/eng/press/pr.aspx?file=03032014_111150eng....

The Central Bank of the Russian Federation (Bank of Russia)

Press Service

The Board of Directors’ Decision on the Bank of Russia Key Rate (Unofficial translation)

The Bank of Russia Board of Directors decided to temporarily increase the Bank of Russia key rate to 7.00% effective from 11:00 Moscow time 3 March 2014. The decision is aimed at preventing the risks for inflation and financial stability arising from the recent increase in financial market volatility.
[end quote]

I like the way the Bank of Russia delicately refers to "volatility" while carefully avoiding the reason for the volatility. Increasing the Russian key rate to 7% is designed to prevent capital flight.

Imagine the shock of Russian investors waking up to international sanctions and the prospect of frozen accounts and a possible foreign investment moratorium. As of this posting, the RSTI is down 12%. I haven't been able to find Russian bond yields but I am sure they are up, which will make borrowing more expensive for Russian businesses and will depress their economy.

The reaction in the developed markets is negative but relatively muted so far.

The "storm" that moved through in early Feb. 2014 was caused by rumors about Chinese and emerging market economic slowdown and was about 5% of SPX valuation. So far, the reflexive flight-to-safety moves are not affecting U.S. or international stocks much. U.S. internals deteriorated (A/D and NH-NL). Treasury bond yields immediately dropped to near their recent lows. The USD and gold did not react strongly.

The most critical commodity in the crisis is natural gas. Interrupting natgas supplies through Ukraine would hurt both Russia and Europe. I doubt that either will try to turn off the pipeline. However, the pipeline runs through western Ukraine and is vulnerable to nationalist attack and disruption. I'm sure that natgas prices and futures are volatile in Europe. U.S. prices haven't been affected yet but these markets are separate.

Europe's economy has been weak, just barely staying out of recession overall. The bank and sovereign defaults of the PIIGS were averted by massive monetary creation by the Troika (ECB, etc.) The ECB is looking to loosen further. The last thing that Europe needs is higher energy prices and higher uncertainty. Not to mention a new dependent like broke, chaotic Ukraine.

From a purely market perspective, the least destabilizing action would be to shrug our shoulders, accept the Russian annexation of Crimea as a fait accompli, and do absolutely nothing else. Any move to punish Russia will probably also punish Europe to a certain extent. The impact of a slowing Europe would also be felt in the U.S. market due to lower U.S. exports to Europe.

Of course, accepting that the annexation of Crimea will lead to stability assumes that Putin will stop there. Not necessarily a good assumption.

Wendy


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http://finance.yahoo.com/echarts?s=rts.rs+Interactive#symbol...

http://www.nasdaq.com/markets/natural-gas.aspx

http://uk.reuters.com/article/2014/03/03/uk-ecb-policy-idUKB...

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