Flaring tensions with Russia threaten to overplay a raft of key US economic data

Macro Outlook

After what could potentially become one of the most significant geopolitical events of recent years, tensions surrounding Ukraine show little sign of properly calming down. If it turns out that not only a passenger aeroplane has been blown out of the sky by a ground to air missile, but Russia is also firing weapons into Ukraine from within its own border, then this conflict has the potential to become a significant amount worse. A civil conflict would become an international conflict which could have huge consequences for the international financial system. The international community would need to inflict seriously punitive sanctions on Russia, whilst Russian President Putin would be certain to retaliate, whether it be on the ground in Ukraine or through the energy markets. The trouble is that, at this stage, even if Russia has not explicitly fired into Ukraine, unless the investigation into the cause of the flight MH17 disaster completely whitewashes Russia of any involvement we could already be on a one way trip towards mutual economic hardship. The cynic in me would say that the West’s Game Theory conflict analysts may have to exonerate the Russians in an attempt to diffuse the situation. Even then, it may not be enough to stop a bad situation getting worse. For once, I hope that I am proved wrong.

Must watch out for: Non-farm Payrolls

Impact: June’s Payrolls number was a big upside surprise and what turned out to be the 5th month in a row (following upward revisions) that a jobs number above as what turned out to be above the 200,000 level that is broadly considered to be the level that the US is adding jobs on a net basis. Expectation is that this run will continue and after weekly jobless claims just fell to their lowest level since February 2006, we could be set for another upside surprise. Analysts will also be looking for further signs of stabilization (or even a pick up) in labor participation. This would be dollar positive.

Foreign Exchange

The strength of the US dollar has been remarkable in the past few weeks. The move in the Dollar Index (.DXY) has pushed above the 80.6 resistance and now the next key level to watch for is 81.3 which ahs been a consistent key pivot level since 2011. This move on the dollar though has been largely data driven and this week the traders will have attention mostly on the announcements from the US. With a whole quarter of Non-farm Payrolls above 200,000 hopes will be high for a strong rebound in the first reading of Q2 GDP. Furthermore the Fed’s revised economic forecasts in the FOMC press conference will also garner a lot of attention on Wednesday, whilst Friday’s employment data will always be grab the attention. Renewed weakness of the euro in the past couple of weeks is unlikely to be helped either this week, if the forecast decline in German HICP is to be believed. With Germany almost single handedly keeping the Eurozone inflation at +0.5%, this forecast decline could re-engage fears of deflation and have traders speculating about QE once more.

WATCH FOR: Although the dollar has benefitted from the geopolitical tensions, the move has largely been data driven. This week, there is a raft of key dollar relate announcements which could continue to pull the dollar higher. Watch for a strong Q2 GDP and ISM manufacturing, any hawkish hints from Yellen and a big Non-farm Payrolls number.

Indices

The remarkable support that Wall Street has continued to find despite the on-going geopolitical tensions in Ukraine has been for two reasons. Firstly due to the economic independence that the US has from Russia (minimal exports to Russia and the energy freedom that shale gas has provided) and also the strength of Q2 earnings season. Around three weeks into US earnings season, corporate announcements have been very strong. Over two thirds of companies have beaten analyst expectations on earnings, but more importantly revenues have also been beating at around the same rate. The tech giants of Facebook and Apple have been strong positives that have underpinned the S&P 500 which has continues into new high ground. Over in Europe, it has been a different story. Russia supplies around 38% of Germany’s natural gas, 35% of its oil imports, and 25% of coal imports, meaning that Russia accounts for around a quarter of Germany’s energy needs. When you see the DAX falling disproportionately compared to the FTSE 100 as news of renewed tensions over Ukraine, it is Germany’s close energy ties to Russia that is the reason why.

WATCH FOR: Tensions with Russia remain paramount for investor concerns which will continue to impact on the direction of the European indices this week. At least though there is a raft of US economic data including ISM manufacturing, the FOMC decision (and press conference) and Non-farm Payrolls.

Other Assets: Commodities & Bonds

The “war premium” that had been ebbing away from commodity prices once more, resulting in a stabilisation in Brent Crude, dragging gold back below $1300 and silver back below $20.50, has started to creep back in again as reports of renewed Russian sanctions have surfaced. Fluctuation of geopolitical tensions (Ukraine, Iraq, Gaza) have been a constant source of price volatility throughout much of 2014 and being ready to move into these safe haven “hard assets” when tensions flare up again is certainly one strategy investors could use.

Eurozone bond yields remain under downward pressure. Although German and French 10 year yields are yet to break to new lows, the peripheral Eurozone yields are looking to regain the downside momentum once more as they seemingly move to price in some form of QE from the ECB. With Spain already below 2.54% at another all-time low, the Italian BTP continues to threaten 2.70% support, below which would again open the flood gates.

WATCH FOR: With a raft of key US data, commodity prices could be volatile. Any ramping up of tensions in Ukraine could also drive investors back into precious metals, oil and also Treasuries, Gilts and Bunds