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At least they’re talking…Ukraine’s delegation is said to have arrived in Belarus for talks with Moscow … the nuclear rhetoric is not helping but for now most see this as sabre-rattling…we said that about the troop build-up. Talks are key to how things play out this week and they are taking place without pre-conditions. Russia’s negotiator said his side is interested in an agreement with Ukraine as soon as possible. This is not a geopolitical commentary, so we leave out too much about the implications from what’s going on vis-a-vis Putin and the future of European security, but I’d say markets are doing a pretty good job of mis-pricing geopolitical risks; they are notoriously hard to price for. This means volatility remains until there is resolution on the ground. For now European stock markets trade lower but well off the overnight lows indicated by futures markets; not such a sharp selloff as we might have anticipated. The FTSE 100 traded about 1% lower, whilst the DAX was off 2% or so. Oil markets have also pared gains after gapping higher last night.

Markets are digesting a raft of fresh sanctions that landed over the weekend: Swift ban, Russian central bank assets frozen, flight bans and all sorts. We have also seen an incredible turnaround in German post-war military restraint as it announced plans to increase the defence budget by €100bn this year. Hensoldt (HAG), a German aerospace and defence supplier, jumped 87%, whilst Rheinmetall (RHM) rallied almost 50%. Other defence stocks rose handsomely: BAE Systems (BA) rallied 13% and Leonardo (LDO) in Italy climbed 15%. Look for Lockheed Martin (LMT) and Raytheon (RTX) later on. Travel bans and air space restrictions left travel socks down; TUI –5%, IAG –3% in early trade.  European banks were broadly lower as investors de-risked from institutions with direct exposure to the Russian economy; Deutsche Bank and Commerzbank both -7%, SocGen and BNP Paribas -8-9%. Raiffeisen Bank (RBI) was off 17%. Sberbank was warning on outflows, ECB says its European branches face collapse. Restriction on Russia + possible retaliation = slower growth for Europe. Bank for International Settlements data on cross border exposure of international banks to Russia shows the most exposed Italy is $25.3bn, France $25.2bn and Austria $17.5bn. The US has $14.7bn and the UK has $3bn.

Stocks broadly fell, oil popped before scrubbing gains, and the ruble plunged as the fresh wave of sanctions on Russia over the weekend were greeted with some concern by global investors. USDRUB plunged to 118, its lowest ever, and was last printing 107.50, down 27% from Friday’s close as the Russian currency collapsed in the wake of tough measures by the West to all but cut off Moscow from the global financial system.

Russia has taken some steps to counter the measures, banning foreigners from selling local securities ahead of what is likely to be a day of carnage for Russian stock markets. Local exchanges will not open until 3pm local time (midday GMT) at the earliest. Meanwhile the central bank has hiked interest rates to 20% from 9.5% in a bid to defend the currency…desperate measures and utterly futile. Russian stock markets are toast.

Crude oil futures leapt, with Brent adding around 5% to trade above $102 before paring earlier gains. This was a swift fade and perhaps does not fully reflect the risks. Another factor to consider is that whilst sanctions don’t bar Russian oil and gas exports, many Western banks are taking matters into their own hands and giving Russian energy a swerve. Meanwhile Iran says 98% of a draft nuclear deal is now complete, which could help keep a lid on prices.

BP (BP) shares fell 7% before paring some of the losses after the company announced it would seek to exit its 20% stake in Rosneft amid huge political and shareholder pressure to do so. A tough breakup for BP… Rosneft contributed $2.7bn in underlying profit last year, just over 21% of its $12.8bn profit for the year. BP could take up to a $25bn from this…mark to market is probably close to zero.

Elsewhere in London, we are seeing major declines for Russia-exposed stocks: Evraz (EVR), Polymetal (POLY), Petropavlovsk (POG), JPMorgan Russian Securities (JRS) and Ukraine-focused iron ore miner Ferrexpo (FXPO). Smaller caps like PetroNeft, Enwell Energy, Eurasia Mining and Raven Property Group were also sharply lower.

In addition to the Swift move, Russia’s central bank is also being cut off and blocked from deploying its international reserves…Putin’s war chest of foreign currency just got smaller. It amounts to Russia being all but cut off from the world’s financial system…cue the de-dollarisation cultists proclaiming this will speed up a bipolar financial system. Whilst I anticipate some relatively high levels of volatility, what is less clear is the path ahead beyond – what kind of dominoes start to fall when you cut off a relatively large economy from the system? Never has such a large foreign currency reserve been wiped out. Question is to what extent this sparks contagion in the global banking system that leads to CBs needing to act to supply the market with the USD it requires? I would expect dollarisation and a shortage of dollars to be the main effect and for a sharp move higher for USD as a result with the natural carry over this would have for peers.

In response to the Western escalation, Putin has placed Russian nuclear forces on high alert – as soon as nuclear hits the headlines we are always in for a rocky ride for markets…but the usual story here is to buy the dip – if there is no nuclear war you win, if there is one, well…but the market still has to dip first.

What do we know so far? It seems the Ukrainians are putting up a much tougher fight than expected by Russian. Nato is gradually pulling together and even Germany appears four-square on the tough anti-Russian sanctions line now.

There are no good outcomes to this crisis. Either Russia wins what would now be a bloody war (as opposed to the quick Blitzkrieg), and Russian tanks are parked on Nato’s eastern flank..Putin emboldened. Or, we need to think of the consequences of Russia losing this war; Putin chased back to his dacha, badly beaten? What does the cornered bear do then? We are in uncharted territory with a hot war in Europe where one of the protagonists has nuclear weapons.

Oil – any spike in energy prices would make inflation worse…does the spike last? Market is tight anyway but futures curve in heavy backwardation does not indicate this is going to get worse…indeed IEA says moving to surplus later this year. OPEC (Saudi Arabia) can act to open the spigots, but OPEC has consistently been unable to meet its quotas. SPR release? Never going to do more than skim off the margins and is not structural. Far better to look at offset with Iran deal for example…or just throw dollars at the Saudis. As for shale, it’s just happening even with oil at $100. Most don’t plan to increase – the 3 biggest shale companies PXD, DVN, and CLR have all said they will limit production growth this year and currently only plan to reinvest what’s needed to keep production flat….$120 Brent could change that equation…but Biden needs to say ‘look this is getting really tough for consumers, open the taps’. OPEC+ meets this week and are seen sticking to the 400k bpd hike script.

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