Eastern Europe

Today, high inflation seems so remote that many analysts treat it as little more than a theoretical curiosity. They are wrong to do so. No matter how much central banks may wish to present the level of inflation as a mere technocratic decision, it is ultimately a social choice. And some of the very pressures that helped to contain inflation for the past two decades have been retreating. Modern central banking has worked wonders to bring down inflation. Ultimately, however, a central bank's anti-inflation policies can work only within the context of a macroeconomic and political framework that is consistent with price stability. Inflation may be dormant, but it is certainly not dead.

While NATO is contemplating its existential purpose in a world where the Cold War has suddenly come back with a vengeance, and the military alliance has found itself woefully unprepared to deal with a Russia which no longer accepts the supremacy of the west (appropriately enough NATO is doing this on a golf course) Russia is also strategizing, only instead of issuing "sharply-worded catchphrases" and hashtags, a Russian general has called for Russia to revamp its military doctrine, last updated in 2010, to clearly identify the U.S. and its NATO allies as Moscow's enemy number one. That in itself is not disturbing: we reported as much yesterday and is merely more rhetorical posturing. Where things, however, get very problematic is that the general demands that Russia spell out the conditions under which the country would launch a preemptive nuclear strike against the 28-member military alliance.

Some believe that actions today were jointly agreed to by the Fed and ECB to allow the stimulus baton to be passed from one major central bank to another. Could this be to help ease the risk-off fallout that is likely to ensue in anticipation of the first Fed hike? Maybe the price action in US equity markets today should serve as an early warning signal.

As we discussed yesterday, Vladimir Putin's apparent 'threat' to EU's Barroso that "If I want to, I can take Kiev in two weeks," prompted both anger and response as NATO reacted by stating a new "spearhead" force of 3-5,000 troops would be flown in to combat any (further) Russian aggression. However, Russia is not happy that the EC President leaked the conversation with Putin's aide Ushakov stating that recounting the private conversation was "inappropriate," "undiplomatic," and "unworthy of a serious political player." More troublingly, the cold-war-tension-like escalation from NATO has prompted Russia to revise its military doctrine to account for “changing military dangers and military threats.”

If last week's disappointing global economic data, that saw Brazil added to the list of countries returning to outright recession as Europe Hamletically debates whether to be or not to be in a triple-dip, was enough to push the S&P solidly above 2000, even if on a few hundreds ES contracts (traded almost exclusively between central banks), then the overnight massacre of global manufacturing PMIs - when not one but both Chinese PMIs missed spurring calls for "more easing" and pushing the SHCOMP up 0.83% to 2,235.5 - should see the S&P cross Goldman's revised year end target of 2050 (up from 1900) sometime by Thursday (on another few hundreds ES contracts).

The global economic downturn of 2008, in particular its monetary facet, readily invites comparison between the troubles of the modern world and those of the Roman Empire; just as Western currencies have declined precipitously in value since their commodity backing was removed in stages starting roughly a century ago, Roman currencies were also troubled, and present a cautionary tale. The Roman coin in use through most of the empire was the denarius, which demonstrated a persistent decline in value, starting from the time of transition from Republic to Empire, and continuing until its decimation during the Crisis of the Third Century AD. Although efforts by Diocletian taken after the monetary collapse are commonly associated with Roman economic reform, there were other efforts by earlier, lesser known emperors that suddenly and unexpectedly improved the silver content and value of the denarius. Firsthand accounts and archeological findings provide sufficient detail to allow examination of these short, if noteworthy, periods of voluntary restorative policies – and their architects.

Last week, Ukrainian Prime Minister Yatsenyuk pushed a bill through the Verkhovna Rada that would see his country’s gas transportation system sold off to a group of international investors. The provisions of the law would permit the transit of natural gas to be blocked. This decision may hurt the fragile industrial recovery in Germany and finish off Ukraine’s potential as a gas transit route to Europe.

• Obama Cools Talk of Strikes Against Islamic State in Iraq or Syria (WSJ)
• Separatists say will allow 'trapped' Ukrainian forces to withdraw (Reuters)
• Ukraine Fighting Surges as Russian-Backed Forces Gain (BBG)
• Missouri police sued for $40 million over actions in Ferguson protests (Reuters)
• BTFDividend stocks? Tesco Slumps as Retailer Slashes Dividend 75% on Forecast (BBG)
• In town halls, U.S. lawmakers hear voter anger over illegal migrants (Reuters)
• Obamacare’s Latest Threat Nears Turning Point in Court (BBG)
• Untangling the Mess of Austrian Bank Hypo (WSJ)
• The billion-dollar fall of the house of Espirito Santo (Reuters)
• Manhattan Condo Resale Prices Reach Record High (BBG)
• California Drought Squeezes Wells: State Considers Regulating Groundwater Use for First Time (WSJ)

From Arab Spring-related uprisings in Libya or Egypt, to a civil war in Syria and now violence in Iraq and the Ukraine, geopolitics are impacting oil. True, geopolitical risk measured by combat deaths does not always correlate well with market volatility. But wars and conflict are easy to spot on an oil price series. With combat deaths rising four fold in the last 10 years, oil markets should prepare for more turmoil. BofA 's Francisco Blanch asks "Can the US preserve geopolitical stability?" America still takes up 38% of global military spending, but appetite for foreign adventures has been low. As an example, a drop in US combat deaths in recent years has been mirrored by a rise elsewhere. Following a drop to multi-decade lows, implied vol in long dated oil options at 15% looks cheap. Oil after US hegemony may not be as steady.

It seems like an eternity ago when futures tumbled last Friday on reports of Ukraine shelling, and "destroying", Russian military vehicles that had entered Ukraine (only to rebound to an unchanged print). It didn't take long for the world to forget all about this latest unsubstantiated incident and move on to "de-escalation" hopes, which this morning have catalyzed yet another rise in futures on expectations that upcoming talks between Putin and Poroshenko in Minsk next week will lead to further easing of tensions. In the meantime, the world media appears to have piled up at the border checkpoint and there is even a live feed of the Russian trucks entering Ukraine. Which is why expect this to be as exciting as watching the S&P levitate on no volume.

As we detailed previously, Bulgaria had been an enthusiastic supporter of the Russian-backed South Stream gas pipeline project, whose construction has stoked tensions between the West and Moscow as it enabled gas supply to bypass troubled Ukraine (thus squeezing the desparate economy back into Russia's hands). In early June, Bulgaria's Prime Minister Plamen Oresharski ordered an initial halt (after Europe offered the nation's suddenly collapsing banking system a lifeline). This time, Energy Minister Vasil Shtonov has ordered Bulgaria’s Energy Holding to halt any actions in regards of the project as it does not meet the requirements of the European Commission. Of course, we assume this decision (to halt a 2nd time) is entirely independent of NATO's deployment of 12 F-15s and 180 troops to Bulgaria's  Graf Ignatievo Air Base.

Following a summit in Brussels, a senior NATO diplomat proudly proclaimed that 'allies' have pledged more spending and will beef up its presence in Eastern Europe. However, likely to the chagrin of President Obama (and the West's narrative), he let slip some uncomfortable truths:

• *NATO DIPLOMAT SAYS PUTIN HOLDS TACTIAL SHORT-TERM CARDS (hhmm, ok)
• *NATO DIPLOMAT SAYS LONG-TERM GEOPOLITICAL TRENDS FAVOR THE WEST (phew...)
• *NATO DIPLOMAT SAYS PUTIN WON'T BE AROUND FOREVER (threat or warning?)

So, all the west has to do is be patient? Wait out Putin? We suspect that 'strategy' may get accelerated at some point.

This is especially the case in Ukraine where the currency has lost more than half of its value versus gold (see chart above and below). Gold in Ukraine Hrvynia is up 70% since the start of 2014. People who own gold in Ukraine would laugh at you, if you said that gold is not a safe haven. As would people in many countries in South America, the Middle East and Africa.

The US is clearly now pushing Russia towards war. But if you read the signs correctly, Russia has been preparing for exactly this outcome for many years.

The western world has placed many sanctions on Russia and its economy. However, Russia holds major leverage over Europe; it has oil and Europe needs it (and may just do a 'deal').