International reaction to Russia to drive investor sentiment this week

Macro Outlook

It is difficult to remain objective about the events that are unfolding in Eastern Ukraine. Reports of the Russian separatists obstructing the humane removal of bodies from the crash site of Malaysian Airlines Flight MH17 are abhorrent, whilst the potential for the flight’s blackbox recorder falling into Russian hands has an all too predictable ending. The problem is that no side will come out well from this. Unless the countries in the EU, such as Germany, that have the closest economic ties to Russia come out with a serious stance against Putin, in an attempt to hold the apparent perpetrators to account, then where does this stop? Although David Cameron has already written strong words, the UK holds little sway on the international stage these days. The economic sanctions need to be ramped up significantly on Russia, whilst this should be a lesson to everyone that being so reliant on a “rogue” country for energy (or anything else for that matter) significantly sways the balance of power too much. In the longer term, if this doesn’t hasten the use of shale gas in UK (and presumably Europe) it would be surprising. Near term though the financial markets will be volatile around the newsflow, with safe haven assets being a prime beneficiary.

Must watch out for: Bank of England meeting minutes

Impact: Governor Carney’s communication has been notoriously mixed of late, but the market is still pricing in a Dec 2014 rate hike. A changeover of Monetary Policy Committee voting members is in progress (June was Andy Haldane’s first meeting), this was the first meeting for Kristin Forbes and sterling traders will be very interested to see how she voted. This could be a very interesting set of minutes as we move ever closer towards a potential rate hike. Recent inflation and wage growth data came after the meeting so it will not be a factor.

Foreign Exchange

The shooting down of Flight MH17 has resulted in a flow into safe haven assets and in forex terms, this means that the Yen has strengthened against major currencies. This is being shown in only the second close of Dollar/Yen below 101.30 this year, a near 6 month low on Euro/Yen and the primary uptrend coming under pressure against sterling. However, that is not to say that the US dollar has also now been gaining ground on a net basis, now having spent the last 3 weeks clawing back lost ground on major pairs. This has taken the Dollar Index back into the key historic pivot area between 80.4/80.6. Just how the geopolitical events unfold could determine whether the US dollar continues to recover. However, there is something for everyone across the major pairs this week which could just add to the potential volatility amongst the pairs.

WATCH FOR: Traders will be looking for the economic data to take the focus off the impact of geopolitical events, with US inflation and housing data a key part of this. Sterling traders will be certainly looking at the minutes of the Bank of England meeting to give clues towards potential easing. Risk appetite could also be given a shot in the arm if the Chinese flash PMI holds up on Thursday.

Indices

Risk aversion does not tend to bode well for equities and in the past few days since events in eastern Ukraine escalated significantly. The German economy has tight links with Russia and the prospect of significant international pressure being ramped up, most likely through the use of economic sanctions, will hit Germany as well. The DAX Xetra has felt this in the past few days, and the relative performance of the DAX against the FTSE 100 has now fallen to its lowest since November. That is not to say that the FTSE 100 is faring too much better, whilst in the US, the Wall Street markets remain remarkably well supported. Despite appearing to be trading around full value, there is no real appetite for profit taking in the US. M&A activity continues to underpin the gains, whilst the big US banks seem to have provided a positive start to earnings season. This week the numbers from Apple will be all important, whilst industry bellwether Caterpillar in addition to results from Coca Cola and McDonald’s will also be of significant interest.

WATCH FOR: Investors will continue to trade on sentiment from how the international community attempts to deal with events in eastern Ukraine. The US economic data includes inflation and housing data which will again lead to speculation over monetary easing. Traders will watch China on Thursday with the flash PMI data that could guide risk sentiment.

Other Assets: Commodities & Bonds

Could this be the start of an oil recovery again? Last week Brent Crude hit a 3 month low below $105 as the price was smashed by rising Libyan oil supplies and weak economic data which suggested a potential glut was approaching. However, the extension of Russian sanctions on Thursday and subsequent terrorist atrocities have seen the price hit a floor and bounce. In the past few months, geopolitical tensions in Ukraine have been able to drive a higher oil price and the reaction towards the end of last week suggests that there could be support coming in again.

Eurozone bond yields have seemingly returned to their downward trajectory as the fears over contagion from Banco Espirito Santo have subsided. Bunds are eying a test of the May 2013 low at 1.15% with Spanish yields also looking to retest the recent June low at 2.54%. The yields on both Treasuries and Gilts have also resumed their decline.

WATCH FOR: Commodities such as the precious metals and oil have bounced on the announcement of Russian sanctions and any further escalation of this story could drive prices this week. If the Eurozone flash PMIs disappoint on Thursday it could signal further flight into government bonds