Conditions for financial markets remain the inverse of Goldilocks.

Stagflation appears to be ever more a reality while the world is now looking at the potential, at least, for the worst nuclear crisis since the Bay of Pigs invasion in 1961 and the subsequent Cuban Missile Crisis in 1962.

Commenting on historic geopolitical events, and financial markets’ reaction to them, is an endeavour fraught with risk.

This was demonstrated over the past month when it became evident that the Russian President’s strategy involved more than occupying the eastern Ukrainian enclaves.

That Vladimir Putin chose a policy of outright invasion was not only a major surprise to this writer but also to most Putin watchers, according to an interesting article published in the New York Times International Edition at the time the invasion was launched (“Image of a pragmatic leader crumbles” by Anton Troianovski, 26 February 2022).

One such was quoted as saying the following: “I don’t understand the motivations, the goals or the possible results”.

This writer can only agree.

The Russian president has over the years seemed an astute chess player who has made the most of a weak hand after bringing his country back from the chaos that prevailed in the mid-1990s, a period when this writer used to visit Russia quite regularly.

Still, the decision to try and invade a country of 44m, as opposed to occupying the eastern part of Ukraine to apply pressure for a de facto federalisation of the country along the lines of the Minsk Accords, makes no sense.

Indeed even if Russian forces had taken Kyiv in 24 hours, which has clearly not been the case, the Russian leader would still have been left with the unpalatable and unviable prospect of becoming an army of occupation in a hostile country; though in this case the hostile country would be much closer to home than was the case with Afghanistan.

If the strategy makes no sense, it is also extremely risky from Putin’s own political perspective.

This is because if the military strategy is not working it weakens his position domestically, most particularly as the impact of economic sanctions bites as well as the general sense of Russia becoming a pariah state in terms of the sanctions imposed by the West.

It is also why the Russian middle class will again be hit hardest as the currency collapses and domestic interest rates are raised, as was also the case when oil collapsed in late 2014.

Bank of Russia key rate and Brent crude oil price

Source: Bloomberg

On this point, the Bank of Russia has raised its key interest rate from 9.5% to 20%, while the ruble has depreciated by 32% against the US dollar since the invasion began on 24 February.

Russian ruble/US$ (inverted scale)

Source: Bloomberg

By way of comparison, the Bank of Russia key rate was raised from 8% in early November 2014 to 17% in mid-December 2014, while the ruble depreciated by 40% and the Brent crude oil price declined by 29% over the same period.

Meanwhile, in very different circumstances the Brent crude oil price is now up 25% since the invasion to US$121/bbl.

Ukraine’s Resistance is Emboldening the West

As evidence of the Ukrainian resistance has grown, the Western world has become more emboldened in its actions in terms of both sanctions and policies announced.

Germany, the weakest link in the alliance against Russia because of its dependence on Russian energy, is the prime case in point.

The decision by German Chancellor Olaf Scholz on 27 February to increase defense spending to 2% of GDP by 2024 looks groundbreaking, as was the announcement on the same day to build two LNG import terminals in Brunsbuettel and Wilhelmshaven.

Both moves are likely to be to the long-term benefit of American exporters, be they exporting natural gas or armaments.

This can be seen in the action in US defence stocks as well as the sell-off in the Gazprom ADR quoted in London.

Gazprom ADR share price in London

Source: Bloomberg

The Dow Jones US Defense Index is up 16.5% since the launch of the invasion while Gazprom’s ADR share price quoted in London has plunged by 90% in US dollar terms before suspension on 4 March.

Dow Jones US Defense Index

Source: Bloomberg

Ukraine Won’t Push China to Take Over Taiwan Just Yet

It is also interesting that China has refrained from open support for the Russian position, even as it has also refrained from outright condemnation; whereas this writer would have expected a far more pro-Russian line from Beijing if the Russian occupation had been confined to the assumed pro-Russian east Ukrainian enclaves of Donetsk and Luhansk.

This in turn suggests that Putin did not clear the extent of his invasion plans with Beijing before commencing which, if true, is somewhat incredible.

China has always maintained the stance of respecting the territorial sovereignty of other countries.

The lack of explicit support from China is also why people are wrong to link the Ukraine issue directly with the Taiwan one.

There is a theory that Putin and China’s Xi Jinping were acting in unison to exploit perceived American weakness.

So if Putin could invade Ukraine without serious consequences, that would also provide an instructive precedent for Beijing and open the way for a similar invasion of Taiwan.

The view here remains that Xi is in no hurry to escalate the Taiwan issue.

True, he stated at the beginning of 2019 that the political division across the Strait “cannot be passed on from generation to generation”, suggesting that he will sort out the Taiwan issue before he leaves power as discussed here before (China Preys On Taiwan’s Chaotic Political Climate To Unify, 21 January 2019).

But Xi is not planning to leave power anytime soon.

The reality is that most of the Chinese actions as regards Taiwan in the recent past, in terms of flying fighter jets over the Taiwan Strait and the like, have been in response to perceived escalations from the US side, be it sending US cabinet members to Taipei in the final months of the Trump administration or, in the case of the Biden administration, sending US navy vessels in conjunction with the Canadian navy through the Taiwan Strait in October and forming a trilateral security pact with Australia and Britain in September which, among other things, will give Australia capability to build and operate nuclear-powered submarines.

The Nordstream 2 Gas Pipeline is Dead

Meanwhile, returning to Europe, if Germany is for now still critically dependent on Russian energy it looks much less likely today that the Nord Stream 2 gas pipeline will ever become operational, despite its €10bn construction cost, fulfilling a long-term American foreign policy objective and, as already noted, opening up a new export market for US natural gas producers.

Meanwhile, Putin’s invasion has also given NATO as an organization a new lease of life, or a new “raison d’etre”.

It should be recalled that it was not so long ago that French President Emmanuel Macron decried NATO as “brain dead” in November 2019.

All these are the complete reverse of the strategic goals of Putin which again underlines the seemingly disastrous consequences of the invasion from the Russian leader’s perspective.

But if he tries to reverse course it is not so easy at this juncture to see a face-saving way out.

About Author

The views expressed in Chris Wood’s column on Grizzle reflect Chris Wood’s personal opinion only, and they have not been reviewed or endorsed by Jefferies. The information in the column has not been reviewed or verified by Jefferies. None of Jefferies, its affiliates or employees, directors or officers shall have any liability whatsoever in connection with the content published on this website.

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