Geopolitical Developments: Putin Plays Offense But Isn’t About To Throw A Bomb

Tomorrow’s Fed announcement will determine the course of markets this winter much more so than the geopolitical games Putin is playing with Biden and a defensive and disunited Europe. The volatility risk premium points to a higher market over the next few days, while my technical reading of key stocks in the S&P 500 is bullish. Yesterday's cross-asset action brought one positive factor for US stocks. Inflation expectations are stabilizing based on measures of Treasuries and TIPS. Expect the S&P 500 to be range-bound over the next few days.

Market volatility reflects this week’s Fed meeting and the need for clarity regarding which tools the Fed will use to curb inflation, since there is no consensus on either the path of inflation or how banks will react to balance sheet reduction. This debate among global investors is fueling volatility and leading to highly leveraged bets being wiped out quickly, as evidenced by yesterday’s thrilling short-covering rally to the close.

The market is not concerned with Putin invading Ukraine, but rather how the drama plays out and what Putin will do next. The main reason for Putin threatening invasion but not carrying through is that he has too many problems internally to risk a war that will make Russians reminisce about the fall of the USSR after its humiliation in Afghanistan. Nearly as important is the likelihood that Russia’s big brother China would not sanction a real invasion due to its negative effect on the global economy, which is already slowing with downside risk.

Were Russia to really invade Ukraine it would incur sanctions that would threaten the global economy because of the impact on commodity prices and inflation. ING notes that conflict with Russia would impact energy markets since Russia is a major producer, as well as industrial metals. “The potential impact in the metals space isn’t limited to aluminium. Russia is a sizeable producer of nickel, copper, palladium and platinum. Therefore, this could tighten up these markets significantly. Russia is the world's largest palladium producer, while it is also an important nickel producer, a market in which there are already concerns over tightness, given the strong demand dynamics.” There is little chance Xi Jingping would stand for this, given that his central bank is actually easing to ward off a sharp deterioration in growth while the Fed is tightening to fight inflation.

I’ve noted Russia’s internal problems in my blog posting of November 30, which stem from both political and cultural factors. These are so numerous that only a rising economy could give Putin confidence that he could take a big risk of war and stay popular. That isn’t case as Russia faces COVID-related problems on top of existing economic problems, and sanctions would only hurt more. Even more risky is what Germany would do in the event of a war. Putin doesn’t want to risk the energy pipeline Nord Stream 2, but Foreign Policy notes “German officials have privately said they are ready to shelve Nord Stream 2, a gas pipeline direct from Russia to Germany, in the event of Russian military action, although such a threat has yet to be made explicitly.” This seems highly likely as Germany is bipolar on Russia (along a leftwing-rightwing axis) and has actually stymied European unity on Russia and helped divide Europe from America. To resolve this bipolarity and keep within NATO’s good graces, Germany would likely shelve the pipeline and that would remove at least temporarily a major lever Putin has over Europe.

It’s more likely Putin is testing Biden’s mettle and driving division with Europe at relatively little short-term cost to himself or the Russian economy. The market is worried about Putin’s next move since he is playing offense and China is not remonstrating, and thus the logical next step is for Russia to deepen ties with nations in America’s sphere of influence, namely Cuba, Venezuela, and left-leaning anti-liberal states like Mexico, Nicaragua, and Argentina. This is a long-term damper on the market, while in the near-term it’s actually the Fed statement on Wednesday that will put an end to market volatility.

Yesterday I added a position in Pfizer (PFE): my other current market positions include a moderate cash position, Amgen (AMGN), American Express (AXP), Goldman Sachs (GS), Johnson & Johnson (JNJ), 3M (MMM), Starbucks (SBUX) and Titan Machinery (TITN) and the levered ETF UPRO.