[ANALYSIS]: RUSSIAN ROULETTE: A major risk to markets (UPDATED FEB 16)

Analysis details (00:30)

BACKGROUND IN BRIEF:

• Ukraine became independent in 1991 when the Soviet Union (USSR) dissolved with the end of the Cold War. Ukraine has been tilting to the West since, as it sought to distance itself from Russia, with a NATO (North Atlantic Treaty Organization) membership also floated.


• Russian President Putin is seeking to regain influence over the former Soviet state. Ukraine insists that Russia cannot prevent it from building closer ties with NATO if it chooses. The US and some other NATO players have shown Ukraine support whilst simultaneously attempting to deter Russia. Moscow blames NATO for undermining the region’s security.


• In 2014, Russia illegally annexed Crimea – an area presented as a gift to Ukraine under the USSR. Meanwhile, the Donbas region (the eastern Ukrainian provinces of Donetsk and Luhansk – near the Russian border) has seen conflict since 2014 after Russia sent troops to support Russian separatists. An agreement was made in 2015 which helped ease the major conflicts but failed to politically unite the sides – with small flare-ups continuing since.


• The Donbas region is seen as a proxy for the tensions. Early last year there have been instances where the 2015 ceasefire was broken. The EU and US have imposed a string of restrictive measures in response to Russia's actions in Crimea and eastern Ukraine.

SITUATION REPORT:

• 
  US President Biden says a Russian attack of Ukraine is still a possibility, Biden and Putin both agree they should engage in negotiations; have not yet verified whether some Russian troops are pulling back. There are now more than 150,000 Russian troops encircling Ukraine and Belarus. Washington will not send US Troops to fight in Ukraine. If Russia attacks through cyber attacks or other asymmetrical means, US and allies will respond, according to the White House.


• Russian lawmakers vote in favour of sending a resolution on the recognition of two breakaway regions in Eastern Ukraine to President Putin, according to Reuters.


• 
  Russia President Putin said Russia has been told Ukraine will not become a NATO member in the near future but that assurance does not satisfy him, wants the issue to be settled now or in the near future through a negotiating process, according to WaPo.


• Russian Foreign Minister Lavrov said Russia will continue dialogue with the West; results are achievable, according to Reuters.


• NATO Secretary General has not seen any signs of de-escalation on the ground although there are grounds for cautious optimism; everything is in place for a new attack on Ukraine.


• 
  Russia does not plan to move its embassy in Ukraine from Kiev, a source told Sputnik.


• Russian army has moved tanks and armed vehicles from Crimea, according to Interfax


• Ukraine's cybersecurity center said websites of Defence Ministry, Privatebank, and Oshadbank are under DDOS attack, according to Tass.


• Russian Kremlin says that warnings from the US that Russia is going to launch a fresh attack on Ukraine on Wednesday is "baseless hysteria", according to Reuters.

RUSSIA’S RHETORIC ON MONDAY:

• 
  Russian Foreign Minister Lavrov and Kremlin spokesperson Peskov both struck conciliatory tones on Monday despite the fruitless weekend call between the Russian and US leaders. It's worth being aware that it revolves around the security proposals: The proposals oblige NATO to stop its eastward expansion, drop plans on granting Ukraine membership, and call for restrictions on the deployment of weapons including nuclear.


• Russia Foreign Minister Lavrov said he can see a way to move forward with talks and part of US response to security demands were unsatisfactory, but part of the response was more constructive. Kremlin spokesperson Peskov said President Putin is "willing to negotiate", has always demanded negotiations and diplomacy, and added the Ukraine crisis was only one part of Russia's larger security concerns.

BIDEN-PUTIN WEEKEND CALL: No breakthrough, as expected.

• US President Biden and Russian President Putin spoke on the phone on Saturday and agreed to stay engaged in the days ahead, according to Bloomberg.


• Putin told Biden that US responses to his demands for security guarantees do not address the Kremlin’s key concern, according to Bloomberg.


• Biden reiterated his warning to Putin that Russia will face severe consequences in the event of an invasion of Ukraine, according to Bloomberg

RUSSIA’S SECURITY PROPOSALS: Despite the string of diplomatic meetings, the security proposals are at the centre of Putin’s interests.

• Russia previously emphasised that it is to formulate its stance after the US responds to Russia’s security proposals.


• On December 17th, Russia released draft agreements on the security guarantees that Moscow expects to receive from Washington and NATO. The proposals oblige NATO to stop its eastward expansion, drop plans on granting Ukraine membership, and call for restrictions on the deployment of weapons including nuclear.


• On December 15th, the Russian Deputy Foreign Minister said if the US and NATO do not provide them with guarantees around security, it may lead to confrontation; and a lack of progress on this would lead to a military response.

UPCOMING MEETINGS:

• German Chancellor Scholz is to meet with the Russian President on Tuesday.


• Ukraine has called for a meeting with Russia and other members of a key European security group in the next 24-48 hours over the escalating tensions on its border.


• Ukraine's President has invited US President Biden to visit Ukraine, according to Reuters.

TROOPS AND DRILLS:

• It is reported Russia has amassed over 150k troops alongside tanks, airpower, artillery, and rocket batteries on its 1,200-mile border with Ukraine.


• Some suggested Russia may not seek to move before the end of the Beijing Winter Olympics on Feb 20th.


• Reports suggest Russia has three main routes for an invasion: 1) the Northern Route via Belarus, 2) Central Route via Donetsk or 3) the Southern Route via Crimea.


• Military drills between Russian and Belarussian troops have been scheduled to take place from Feb 10th to 20th. Russia also conducted drills in the Black Sea.


• Ukraine's army will conduct military drills from Feb 10th to 20th in response to Russian exercises in Belarus near the Ukrainian northern border.


• European countries have also been relocating troops to EU countries close to Ukraine.


• Russian Deputy Foreign Minister called reports of possible US THAAD missile systems being supplied to Ukraine as a provocation, via Reuters citing Ria.

Source: 

BBC 

POSSIBLE ESCALATION:

A senior US official said the US and European responses on Ukraine may not be identical.

WAR: Rabobank believes there is a higher risk of military action than markets are pricing. “Crucially, Russia’s actions would unilaterally redraw the map of Europe, risk refugee flows west, and have enormous market implications.”, the bank says.

SANCTIONS: Analysts at JPM highlight potential sanctions against Russian oligarchs, Nord Stream 2, Russian financial institutions, Russian sovereign debt, Russia’s energy sector, the SWIFT payments and RUB convertibility. JPM suggests that there has been concern over the collateral damage to the global economy and Russian citizens, albeit the likelihood of sanctions has lately increased. Recent reports have suggested that President Putin himself could be a target of potential sanctions.

CYBER ATTACKS: The threat of cyber warfare cannot be discounted. Ukrainian government agencies were recently attacked by a group of hackers some say have links to Russian secret services, although this was not confirmed. The Department of Homeland Security also warned that Russia could launch a cyberattack on the US in retaliation for any defensive moves of Ukraine.

MARKET IMPLICATIONS:

ENERGY: Russia holds over 30% market share in Europe for both natural gas and oil. To alleviate some of this threat, the US said it is engaging with LNG suppliers to manage storage and diversion to Europe if needed. However, Saudi Arabia, Kuwait and Iraq would struggle to cover the shortfall in crude supply created by a blanket ban on Russian energy exports as they have already allocated their annual term supplies, according to Argus sources, while Qatar will meet with President Biden on Monday.

• 
  OIL: Analysts at Rabobank suggest war could see oil hit USD 125/bbl amid elevated risk-premia and higher transit costs, whilst sanction (assuming all countries stop purchasing Russian oil) could see prices rise to USD 175/bbl. JPM believes oil could spike to USD 120-150/bbl in the event of sanctions.


• 
  GAS: The Nord Stream 2 underwater pipeline (linking Russia and Germany) will likely be caught in the crossfire. The pipeline is awaiting certification for use. While current supplies will not be affected, the risk to future supplies will substantially increase. This, alongside low European natgas stocks, could significantly increase European gas prices and seep into global oil markets, according to JPM. Note: China and Russia agreed to a 30yr gas deal via a new pipeline and settled in EUR.

METALS: Russia holds a large market share of total exports in nickel (~49%), palladium (~42%), aluminium (~26%), and platinum (~13%), whilst it also exports steel (~7%) and copper (~4%). A supply disruption will naturally lead to higher prices. Some desks however argue that sanctions would be more detrimental to the global economy given how integrated the above metals are to everyday goods, whilst a rush to stockpiles will further aggravate the ongoing supply chain problems.

INFLATION/GROWTH: With Russia being a large contributor to energy and metals, officials are beginning to sound concerned over the potential inflationary impact from escalations. IMF's First Deputy Managing Director warned an escalation in the Russia-Ukraine conflict could result in a 'bigger, broad-based increase in commodity prices, and could increase risks of entrenched inflation expectations, feeding into wage-price spirals”. ECB Governing Council member Simkus also suggested the Russian related tensions are a bigger cause for uncertainty than Omicron. JPM warned a spike higher in oil and subsequent inflationary pressure would be deleterious to growth.

STOCKS: Traditional risk-off selling could be expected in the event of a war. That being said, in the midst of earnings season and the central bank pivot, equities could be distracted (at least briefly) from events in Ukraine depending on the severity and duration of the situation. Sanctions meanwhile will likely be contained to Russian equities.

FX: In the event of a war, desks suggest traditional risk-off is expected with safe-haven flights into the JPY and CHF. EUR meanwhile will not be well-placed given Europe’s likely involvement. The RUB and UAH will likely slump. Meanwhile, additional sanctions will likely see the RUB under pressure, but Rabobank believes this could tactically benefit Russia as “it would give it room to cut the US dollar prices of its exports for those willing to deal with it … This could potentially exacerbate the sharp price bifurcation in global commodity”, Rabo says.

RATES: A risk-off scenario from war would likely lead to lower yields and a flatter curve in the immediacy, whilst longer-term impacts from the inflationary effects could then take over. In the event of sanctions, some argue that sanctions on large Russian banks could see credit spreads blow out.

AGS: Russian and Ukrainian grains exports (wheat, barley, corn) account for around 24% of the global total, whilst fertilizers out of the region also represent a large global export share. Supply interruptions will naturally bolster prices.

RHETORIC:

RUSSIA: Kremlin has denied plans on invading Ukraine, suggesting that the troop build-up is within its territory and should not cause alarm. Moscow has strongly criticised the US and its NATO allies for their involvement and part in providing Ukraine with weapons. Russia has also accused Ukraine of boosting its troops in an attempt to retake control of the Donbas region.

US: President Biden told the Ukrainian President this month that the US and its allies "will respond decisively if Russia further invades Ukraine." Biden also floated the idea of potential personal sanctions against Russian President Putin.

UK: UK PM Johnson previously warned a Russian invasion of Ukraine would be a "painful, violent and bloody business" for President Putin.

FRANCE/GERMANY: Both countries have expressed concerns about additional sanctions against Russia amid the knock-on effect it will have on the Euro-area economy. The two sides are pushing harder for a diplomatic path.

UKRAINE: Despite the uneasy mood, Ukrainian officials have recently been downplaying the severity of the situation but continue to seek a diplomatic route.

FUTURE RISKS: 

The Russia-Ukraine developments will be closely watched as a proxy for the China-Taiwan tensions. China will likely calibrate any move depending on the fallout from the Russian situation.

16 Feb 2022 - 03:30- MetalsGeopolitical- Source: Newsquawk