Twixt Europe and Russia, Ukraine
Is feeling incredible strain
As diplomats leave
The markets perceive
That risk is becoming a bane

The fear is that war is in view
At which time the best thing to do
Is buy francs and yen
And Treasuries, then
Be ready for stocks to eschew

While it is true that the Fed meeting on Wednesday is of significant importance to market participants, there is another, much greater concern that has risen to the top of the list today, the growing sound of war drums in the Ukraine.  Both sides seem to be increasing both their activities and their rhetoric, and financial markets are really starting to take notice.  The immediate losers have been on the Russian side as the MOEX (Russian stock market index) is down 6.1% so far this morning and 15% YTD.  In addition, RUB (-1.5%) is the worst performing EMG currency today and this year, having fallen -5.0% so far.  The implication is that international investors are fleeing given the threats of retaliation by the EU and NATO in the event Russia actually does invade.

The latest headline from the EU is, FURTHER MILITARY AGGRESSION TO COME AT SEVERE COST.  You can see why owning Russian assets seems quite risky here as on a military basis, there is probably very little the EU or NATO can do in response to an invasion.  But they can certainly impose much more severe economic sanctions and even boot Russia from the SWIFT system, removing the nation’s access to dollars for any transactions.  Of course, given the fact that Germany is so reliant on Russia for its natural gas supply, which by the way has seen prices explode higher this morning in Europe by 12.3%, it does seem unlikely that the most severe sanctions will be imposed.

Will this devolve into war?  There is no way to know at this time.  My take is neither side wants a hot war as those are extremely expensive and difficult to prosecute, but President Putin has an agenda with respect to the West’s attitude toward the Ukraine and what constitutes the Russian sphere of influence.  Arguably, one of the big concerns is that leadership in the West lacks both real world experience and any mandate to “protect” the Ukraine.  However, they also don’t want to look either foolish or weak to their own constituents.  I fear that pride and hubris on both sides could result in a much worse outcome than needs to occur.  For a long time, I read the Ukraine tensions as a negotiating tactic by Putin to achieve a greater buffer zone around Russia.  Alas, the situation seems to have deteriorated pretty severely and pretty quickly.  At this time, one must be prepared for a more dramatic and negative outcome, one which is likely to see traditional havens like yen, Swiss francs, the dollar, and Treasuries rise dramatically.

Apparently, President Xi
Does not like the FOMC
As Jay keeps implying
That rates will be flying
And Xi can’t force growth by decree

While Covid has been an extraordinary burden on the world in so many different ways, as with all things, there has been a modicum of good as a result as well.  For instance, the WEF has been downgraded to a bunch of Zoom calls with no elite hobnobbing and very little press overall.  However, that elite cadre persist in their efforts to rule the world by decree and I thought it worth highlighting something that didn’t get much press last week when it occurred but offers an indication of China’s current economic thinking.  President Xi’s speech included the following, (emphasis added) “Second, we need to resolve various risks and promote steady recovery of the world economy. The world economy is emerging from the depths, yet it still faces many constraints. The global industrial and supply chains have been disrupted. Commodity prices continue to rise. Energy supply remains tight. These risks compound one another and heighten the uncertainty about economic recovery. The global low inflation environment has notably changed, and the risks of inflation driven by multiple factors are surfacing. If major economies slam on the brakes or take a U-turn in their monetary policies, there would be serious negative spillovers. They would present challenges to global economic and financial stability and developing countries would bear the brunt of it.”

Boiled down, this comes to Xi Jinping basically asking (telling?) Jay Powell to avoid raising rates as that would be a problem for China, as well as other EMG economies.  Now, I don’t believe that Chairman Powell is overly concerned about China, but I do believe that while the tightening of policy is very likely to start, it will be short-lived as the economic situation proves to be less robust than currently thought.  However, I thought it instructive as backdrop for recent actions by the PBOC and as a harbinger of the future, where interest rates there are likely to continue declining.  However, nothing has changed my view that the renminbi (+0.2%) is going to continue to strengthen this year.

Ok, so a tour of markets makes for some pretty sad reading this morning.  While the Nikkei (+0.25%) managed to eke out a gain, the Hang Seng (-1.25%) could not despite ostensible positive news regarding Chinese property developers being able to sell some properties.  Europe, though, is bleeding badly on the Russia/Ukraine story (DAX -1.8%, CAC -1.7%, FTSE 100 -1.2%) with the UK clearly the least impacted for now.  Meanwhile, US futures, which had spent the bulk of the evening in the green, are now lower by -0.25% across the board.

Treasuries are playing their haven role like Olivier, rallying further with yields declining another 2.5bps, taking them 15bps from recent highs.  Bunds (-2.4bps), OATs (-1.9bps) and Gilts (-3.3bps) are all seeing strong demand as well as investors flee to the relative safety of fixed income.

Turning to commodities, oil (-0.2%) is in consolidation mode, although the uptrend remains strong.  NatGas in the US (-1.0%) is clearly dislocated from that in Europe but feels very much like it is developing a base around $4/mmBTU.  Gold (+0.4%) is proving more of a haven these days despite the dollar’s strength, although industrial metals (Cu -1.8%, Al -0.85%) are under pressure today.

And finally, the dollar is showing its traditional haven characteristics as well, rallying against all its G10 counterparts and most EMG currencies.  SEK (-0.8%) and NOK (-0.75%) are leading the way lower, arguably because of the proximity of those nations to the Ukraine and the escalation of military and naval activity in the Baltic and North Seas with both Russian and NATO ships and submarines seen.  AUD (-0.7%) is obviously feeling the impact of weakening commodity prices as well as the general dollar strength.  The rest of the bloc is all weaker, just not quite to this extent.

Aside from the RUB (now -2.0%), PLN (-0.9%), ZAR (-0.9%) and CZK (-0.85%) are the worst performers this morning in the EMG bloc.  The zloty story is interesting given central bank comments that “Polish rates should rise more than the market expects”, which would ordinarily be seen as currency bullish, however, given Poland’s proximity to the Ukraine, one cannot be surprised to see investors selling the currency.  The same is true of CZK, although frankly, other than a pure risk-off play, I can see no news from South Africa.

This is a big data week with far more than the Fed on tap.

Source: Bloomberg

So, while of course the FOMC meeting is the primary piece of data, both the Claims and PCE data is going to be carefully scrutinized as well for indicators of the current economic situation and the Fed’s likely reaction function.  As of now, no Fed speakers are scheduled after the meeting for the rest of the week, although I imagine we will hear from several by the end of the week.

As to the dollar, right now, its haven status is all that matters.   Look for it to continue to perform will unless there is a real de-escalation of the Ukraine situation.

Good luck and stay safe
Adf