Nevertheless, following recent risk-off price sessions and the fact that the referendum did not lead to any notable immediate violence, there may be space for an immediate relief in bond markets, and some short-covering in FX (CEE) early this week. Our baseline is that the conflict will not evolve to the level where tough trade/investment sanctions are imposed or even to the level where energy supplies are cut off from Russia to Europe. Therefore, we also believe that markets will revert to look at fundamentals within weeks.
Early results showed an overwhelming 95.5% of those voting favoured joining Russia. The head of the referendum commission put the turnout at 83%, which looks high considering many had said they would not take part at all.
The US and EU quickly repeated the referendum was illegal. President Obama had a call with Mr Putin, saying the Crimean vote took place under duress of Russian military intervention and would not be recognized, something Mr Putin disagreed with. Mr Obama added no diplomatic solution was possible in the midst of large-scale Russian military exercises on Ukraine’s borders, so no quick solutions are in sight.
Likely sanctions on Russia to be soft
Both the EU and the US consider the referendum “illegal and illegitimate” and have in advance threatened to impose sanctions on Russia. EU foreign ministers are scheduled to meet at 09:30 CET on Monday. They will probably decide on a first wave of – presumably rather soft – sanctions. These could include visa restrictions and the freeze of accounts of a defined group of persons, but probably not tougher trade sanctions. Russia could lose its G-8 status and planned German-Russian government consultations could be cancelled. The crisis will also be on top of on the agenda when EU heads of state and government meet on Thursday/Friday.
Over the next weeks and possibly longer, the diplomatic conflict about Russia’s action in Ukraine is likely to linger on. The word “Ukraine” means “borderland” and that already explains the country’s inner conflicts. As an important transit country between the East and West, Ukraine is likely to remain in the headlines. The crisis could – and we stress the word COULD because we don’t know – spread to other parts of Ukraine and in a worst-case scenario to other post-soviet states in Central Asia. Various steps of escalation are possible. However, we still don’t consider an escalating trade war with Russia, stopping oil and gas exports as likely (see also our comment from 2 March).
Upside risk to oil and gas prices cushioned by abundant inventories
After a fall in prices Thursday, European Brent oil and natural gas prices regained lost territory Friday afternoon. The short term future fluctuations in oil and gas prices will to a large extent be dependent on the severity of the response by the EU and Ukraine to the outcome. In the short term, we expect that the movements in oil and gas prices will be cushioned by abundant supplies from high natural gas inventories and seasonally falling demand. That limits the macro implications for Europe for now.
An escalation of the conflict that influences energy supplies could of course push energy prices much higher. The two sides are mutually dependent as Russia accounts for 32% of oil (crude and products) and 30% of natural gas consumption in Europe (of which 50% is transported via Ukraine), while Europe accounts for 57% of oil and around 65% of total Russian natural gas exports. However this interdependence is also the argument against the conflict reaching a level where energy is cut off to Europe.
Bonds still with value amidst uncertainty
Despite the still tense situation and a lot of uncertainty, it is not out of question that we might see some relief on bond markets on Monday (a small temporary correction higher in yields). After all, e.g. the German 10-year yield is already trading at its lowest level since last summer (around 1.55%). Many took a cautious stance already ahead of the referendum last week, while the news flow over the weekend did not include any major surprises, while fresh bouts of violence were largely avoided.
Going forward, the upside for long yields still looks quite limited in the near term, and risks remain tilted to the downside in yields. The Crimean situation is far from resolved, and current yield levels do not appear to illustrate high expectations that the crisis would take turn for the worse, which is possible, albeit not our baseline scenario. If flight-to-safety flows picked up again, US Treasuries would likely be the main beneficiaries, though German bonds would rally as well, while curves would see bull-flattening. Bonds thus continue to offer value amidst cautiousness.
FX – potential for near-term short covering in CEE
The situation in Ukraine was probably one driver behind some strengthening of safe-haven currencies (JPY and CHF) over the past week, although China probably was another driver behind these moves. At the same time, it only amplified RUB weakening, which had started well before the events in Ukraine, and kept under pressure some regional Central Eastern European currencies over the past few weeks. With only cosmetic sanctions from US/EU now widely expected, it seems that the markets will be up to some short covering in these currencies early in the week.
The CEE currencies, seen as proxies, will remain most sensitive to the news from Ukraine/Russia for now: Poland, with geographical proximity and trade links, Hungary with bank exposure (OTP). In a bad scenario, with energy prices increasing, the currencies of countries with large foreign financing needs will be vulnerable too (in particular TRY). Continued tensions will remain broadly supportive of the most liquid currencies, EUR and USD. Though should the crisis escalate, the EUR will also suffer vs. the USD (relative growth, monetary policy), while the JPY will strengthen a lot.
Nordea