Markets

Disruptions to energy markets and the possibility of a geopolitical paradigm shift make for a highly unpredictable environment.

The latest talks between Ukraine and Russia ended without any breakthroughs reported. Ahead of negotiations, Moscow’s demands were outlined by Kremlin spokesman Dmitry Peskov, who called for Ukraine’s recognition of Crimea as Russian and eastern Ukraine separatist areas as independent, as well as the country rejecting "any aims to enter any bloc."

In terms of the following steps, Russia Foreign Minister Sergei Lavrov will meet with Ukraine’s Foreign Minister Dmytro Kuleba in Turkey on Thursday, according to Axios. Such talks would represent the highest-level negotiations yet. While a positive step at face value, there is no evidence of de-escalation on the ground, with fighting around Kyiv continuing to escalate.

It is challenging for European equities investors, with market and price movements extreme in both quantum and speed. Outside of the fact that the market took a swift decision to mark Russian exposure to almost zero, speculators also took a fierce view on the second layer sanction effects on Europe from a prolonged war in Ukraine through the lens of the euro and European Banks.

While we wait for quants to dial in on the indirect exposures and implications on the SX7E, an 18% move down on the week seems extreme (which is down more than 30% from the peak).

While there has been some contagion outside of equities (FX vol and basis move) and risk beats are feeling the stagflationary angst, central banks are likely to contain any funding pressures in the event of a further escalation geopolitical front.

In many ways, given the length of time this has gone on with the possibility of all sides becoming further entrenched in their positions, the geopolitical situation seems likely to get worse before it gets better—although we should reach a point at which equities start to price in a light at the end of the tunnel before it becomes obvious.

Gold

Russia cutting VAT on gold purchases and the likely conversion of foreign exchange savings into gold will add to incremental demand for the yellow metal.

The potential sale of central bank gold reserves could have the opposite impact, but this would likely be done as a private transaction, with gold kept as stock and unlikely to enter the clearing system. The gold narrative and flows are evolving. We can no longer look at the relationship of the real yields for cues as to how the XAU/USD should trade.

Forex

Euro 

EUR/USD collapsed at yesterday's Asia open as the sum of Europe’s fears was encapsulated by the US and EU discussion to embargo Russian oil. In one fell swoop, the market priced in recession and cleaned the slate of ECB rate hikes.

However, the run-up to the emergency EU summit on Mar. 10-11 is very market relevant. 

Already reports have started to emerge about a decision for a new energy crisis ‘recovery fund,’ similar to the EUR750 bn pandemic recovery fund, Russian imports begin to get reduced, and the EU launches a significant fiscal package to deal with the fallout. Indeed this could provide a soft cushion for the EU economy and help the EURO stabilize.

I would be cautious of chasing the EUR lower ahead of this week’s EU summit. While the ECB is usually slow to react, it is often effective. 

CHF 

Although the SNB pushed back in the press, EUR/CHF broke parity overnight. Safe haven flows into the Swiss franc are likely to accelerate. The Swiss 'home bias' is expected to strengthen.

Due to the inflation pick up in the EU, and at home, the SNB’s tolerance for a stronger CHF is also unlikely to change materially below parity. Despite the new line in the sand talk being discussed in media around parity, I think the level is closer to 95.