Ukraine Putin amp market impact

No more discount

Russia’s agreement with Yanukovych enabling the Ukraine to buy Russian gas at a discount may not be renewed at month-end after the fall of the Russia-backed government in Kiev.

Teetering on the verge of bankruptcy, Ukraine is in dire need to contain the cost of its gas imports and keep the remainder of Moscow’s $15 bn loan to the extent that:

i)             it walked out of an economically valuable  trade deal with the EU and;

ii)            it was willing to lower the cost of lease to the Russian navy fleet in Crimea.

The main reason Russia will insist on keeping Ukraine in “friendly” hands is to secure its Europe-bound gas exports, most of which pass through the Ukraine. A 1/3 of Russia’s gas is exports via Ukraine. Russia is far from bankrupt, but it remains eroded by a falling currency and deteriorating current account balance.

Russia stands out from most emerging market nations in that it boasts a current account surplus, instead of a deficit, but such positive balance its at lowest level since Q4 1998, while the nation’s official international reserves have reached $498.9 bn, the lowest in 3 years. The ruble has fallen to 4-year lows against the USD and is vulnerable to further declines near 40.00.

But no risk premium

Just as Russian troops remain beyond their legally authorized borders in Georgia for over 4 years, they are doing the same in Ukraine. There was no noise from the West over Georgia and there is unlikely to be any NATO military engagement beyond the token show of verbal interventions. One possible route is for the US & EU to impose economic sanctions on Russia and risk exacerbating the fall in the ruble. Putin will avoid this by eventually compromising/ agreeing over setting elections in Ukraine, while keeping control over Crimea.

Market volatility will arise from any signs of:

 i)             armed altercations inside the Ukraine triggered by Russian troops;

ii)            announced cuts in gas flows to Ukraine/rest of EU

The chart below reveals the expected divergence between gold and bond yields as the former gained on the broadening reality that Fed tapering is no equivalent to tightening of market conditions and the latter dragged by US data weakness.  The Swiss franc is quickly closing on the yen as the year’s strongest performing currency as the events in the Ukraine intensified from demonstrations in late autumn to human casualties and a government collapse this year. The recent divergence between falling yields and record-breaking equities has finally waned as stocks react to the reverberations in the Ukraine.

The Swiss franc is likely to garner fresh gains due to its isolation from the EU and reinforced role as a refuge for any capital flows away from the Eurozone in the unlikely event that Germany is dragged into the conflict. The Japanese yen may also continue gaining due to its geographical isolation from the region, its usual role as a safe haven and capital flow spillovers from ongoing slowdown in China.