Equity markets breathed a sigh of relief yesterday, unwinding protective hedges placed on Friday after Crimea formally applied to join the Russian Federation and there was little military action when the referendum results were released. Despite the US and EU imposing personal sanctions on Crimean and Russian officials, the lack of violent incident and hope for diplomatic resolution helped markets recover from Friday’s losses, with the S&P adding almost 1% to its valuation, while cash VIX unwound over 2 vols to close the day at 15.64%. The Loonie managed to also gain back some of its losses from last week, with USDCAD sliding into the mid-1.10s on increased market risk appetite that boosted high-yield currencies.
While there are still a number of avenues for which the annexation of Crimea could deteriorate relations between Russia and the rest of the western world, the next few weeks will be telling as to how this whole situation plays out. Although seen as unlikely at this point, worries are that Putin will not stop with just the Crimea region of Ukraine, but use this annexation as a way to gain access to the remainder of the country. More likely is that economic sanctions are imposed on Russia once the United States Congress is back in session next week, although there is an argument to be made that Western Europe has more to lose in the sanction game than Russia, with the latter still being able to trade with China and impose pain on the former by cutting off Natural Gas supplies. The basis of how negotiations unfold is a tricky one from a game-theory standpoint, with Russia accepting the referendum as legal because of their belief the new government in Kiev is illegitimate, while the US and Europe points out the referendum was not conducted according to Ukrainian law. Add in the fact that the Russian oligarchy could stand to benefit dramatically if oil prices rise on impending sanctions while still being able to trade with China, and the negotiation position of the west become a little trickier. One thing is for sure, money markets and currencies will continue to be headline driven throughout the week, susceptible to “risk-on/risk-off” sentiment as the situation continues to develop. From our perspective the lack of Ukrainian military involvement on Sunday reduces the risk of escalation moving forward, although it is not soon enough to advise the event risk has totally diminished.
The overnight session saw Asian stocks piggyback on the gains seen on Wall Street, although these were somewhat muted as optimism faded ahead of Putin’s speech early this morning. The Nikkei was able to post a gain of 0.94%, despite USDJPY ebbing lower throughout Asia, heading into the low 101s. The weakening trend in the CNY has continued after the Chinese government widened the daily trading band in the yuan, falling to its weakest level in 11 months as USDCNY rises to the 6.19 mark. Also aiding in the drop of the yuan overnight, new home prices in China slowed in February, posting only a y/o/y increase of 8.7% compared to the 9.6% registered in January. The Shanghai Comp was little changed on the session, finishing just moderately in the green after the worse than expected macro data.
Turning our attention to Europe, equities started out on their back-foot as safe-haven asset classes caught a bid after a disappointing survey result from the ZEW institute on economic sentiment in Germany. Both the future expectations and current situation readings missed the median analyst estimate, coming in at 46.6 (vs. exp. 52.0) and 51.3 (vs. exp. 52.0) respectively, its third straight month of declines. Respondents noted that the situation in Crimea was weighing on the economic outlook for Germany, with experts unsure as to how the sanctions with Russia would affect future performance. Although not in mentioned specifically in the report, EURUSD north of the 1.3900 figure isn’t doing wonders for Germany’s export sector. The EUR had slipped below the 1.3900 figure against the USD, but has since been able to recover its overnight losses, boosted off a ramp in risk appetite ahead of the opening bell in North America.
North American equity futures have rebounded from the lows experienced overnight, gaining momentum after the completion of Putin’s speech earlier this morning, which also helped USDJPY ramp into the mid-101s. Despite a pageant-like address to the Russian and Crimean people, the formal annexation of Crimea and the city of Sevastopol managed to pull S&P futures out of negative territory, shaking off comments from Putin that Russia felt robbed by the breakup of the Soviet Union and that Russia couldn’t imagine a separate Ukraine and Russia.
The early-morning data dump in North America hasn’t had too much of an effect on equity futures thus far, with US CPI coming in essentially in-line with expectations, while housing data was mixed. Inflation data showed that headline consumer prices increased by 1.1% on a y/o/y basis much lower than the 1.6% print from January; while unlikely to influence the Fed to withhold another $10bln decrease in asset purchases, it does increase the probability we see some form of qualitative measures added into the Fed’s forwards guidance. The housing data was basically a wash, with both starts and permits increasing from January to hit 0.91M and 1.0M respectively, but starts falling short of analysts’ estimates while permits topped expectations. North of the 49th parallel saw manufacturing sales increase by 1.5% in January, clawing back all of December’s losses and beating expectations of a 0.6% increase. The combination of positive equity performance, a bounce in oil, and constructive domestic data has the Loonie continuing its run from yesterday, with the rally pushing USDCAD into the low 1.10s.
Looking ahead to the remainder of the session, Bank of Canada Governor Stephen Poloz is set to speak in Halifax just before 12:00EST, with Loonie traders parsing his speech to try and gain clues as to if his outlook for the Canadian economy has been amended at all since the last BoC interest rate decision. It is likely Poloz will reiterate the bank remains data dependant as to their assessment on the next movement of interest rates, and should he be asked about the price action of the Loonie, will likely continue to telegraph the currency’s path is market determined and the BoC doesn’t have a view or target for the exchange rate. Should Poloz be a little more upbeat on the inflation outlook after the January figures there is room for the Loonie to gain some strength, but we would be cautious as to the size of the move considering inflation is forecast to ebb lower when Friday’s numbers are released, with the headline reading sinking back below 1.0% on a y/o/y basis. Make sure to speak with your dealing teams in preparation for the week ahead, as option-based hedging strategies that allow for upside flexibility could be good ways to play the upcoming week that is chalked-full of economic data releases.