Rabobank: War May Delay, But Should Not Derail Central Banks' Plans

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by Tyler Durden
Wednesday, Mar 02, 2022 - 02:45 PM

From Michael Every of Rabobank

A common enemy

Nothing unites people like a common enemy. Putin is learning that lesson the hard way. His plans to turn Ukraine into a Belarus-style puppet state and avoid NATO expanding east so far seems to have achieved the polar opposite. The West stands united, and Putin’s actions are driving countries that have been neutral to date into the arms of the Western alliance.

The Finnish attitude towards NATO membership is shifting rapidly since Russia invaded Ukraine, and a petition for a referendum on joining NATO forced parliament to discuss the matter yesterday. The debate did not lead to an immediate exercise of Finland’s option to join the alliance, but Prime Minister Marin stated that these discussions “will continue in an organized, calm, measured and considered manner.” She added that “We all felt that the security situation has changed significantly,” and “are seeking the most sensible way forward for Finnish security.” The fact that the possibility of joining NATO is actively being considered is still a major shift in thinking from a Finland that has historically held off on the idea out of fear that it might anger Russia.

Similarly, Ukrainian President made an emotional appeal to MEPs to join the European Union through an accelerated procedure. Moving as his speech was, it is not up to the European Parliament, but the heads of state, to decide on these matters. Eight of them –including Poland and the Baltics– have already backed Zelensky’s request to become an EU member. Not all countries may be as eager to accept Ukraine’s application, though. One obvious concern is the implication that accession would have in terms of the EU’s mutual defense clause, considering that Ukraine is currently at war. No one will sell you insurance while your house is already burning either. However, Zelensky’s haste is understandable: considering that it can easily take a decade for countries to become EU members, the house may already be burnt to the ground!

Even without Article 42.7 of the Lisbon Treaty, some countries may prefer to tread lightly. Putin’s entire campaign was designed around the goal to avoid that Ukraine joins the Western alliance. The Russian president is already resorting to much more drastic measures after the Russian army met a much fiercer resistance than they had probably anticipated.

And while the West unites, Russia finds itself increasingly isolated. China has been trying to balance its relationships with both sides of the conflict to safeguard its own interests. However, the country now officially referred to the conflict as a ‘war’, a word China had carefully avoided so far, and Beijing expressed “extreme concern” about the potential for civilian casualties.

Speaking to Ukraine’s foreign minister, China also indicated that it is willing to mediate in the conflict. China may see the current crisis as an opportunity to present itself as a ‘defender of the current world order’ (if only to buy time for itself), as the US has –over the past decade– taken a less prominent role when it comes to policing the world. That process seems to have taken a turn now with the recent sanctions on Russia and President Biden’s strong remarks regarding the situation in Ukraine in his State of the Union Address (which even drew unusual applause). Still, the fact that the US has already chosen a side in this conflict could also hamper it as being able to provide the Russian leadership an off-ramp in this situation which –thus far– has only escalated. Secondly, the President also has big fish to fry in his own country, as underlined in that same speech. Despite the global importance of the war in Ukraine, Biden spoke just 10 minutes of his hour-address on the subject. The US President spent the majority of his speech on domestic affairs like his “Build Back Better” initiatives that have basically hit the rocks.

Back to markets and the impact of recent sanctions, Bloomberg finds that amidst all this, Russia ETFs have seen inflows last week. Like Bloomberg’s Cameron Crise, I can’t help but wonder who can stomach that risk now. Sure, an entire generation of investors has now been conditioned to believe that monetary policy will always come to the rescue during a dip, but it’s hard to see how the Central Bank of Russia can save equity investors from sanctions and boycotts. For the same reasons, Russian equities don’t seem to be the next ‘Gamestonk’ that can be propped back up purely by willpower and memes. Moreover, I highly doubt that Russian assets can expect the same sympathy as some of the Main Street names a year or so ago. In fact, that sympathy may be reserved for Ukraine, which sold USD 277 million in war bonds yesterday. Redditors are looking to buy [warning – strong language] while meme-ishly suggesting that they might be able to “name some tanks” as if this were a crowdfunding campaign.

Meanwhile, the rest of the market is more concerned with the economic fallout of the war, resulting in a sharp selloff of equities, as investors flocked back into fixed income. 10y Bund yields dropped more than 20bps between the open and close. The growing prospects of a more protracted war and increasingly brutal tactics employed by the Russian military are casting doubts over the economic outlook. Over the past few weeks we have written extensively about the potentially stagflationary combination of higher inflation and lower growth as a result of the conflict – piling on to the headache that central banks were already facing. For several central banks this may come down to choosing the lesser of two evils.

Crucially, though, the war has not fundamentally changed the choice between fighting inflation or supporting growth; it only exacerbates the potential extremes of the two outcomes. Of course, uncertainty weighs in as well, and central banks may be wary of potential liquidity stress – even if that seems less likely than in previous crises. On the other hand, prospects of less hawkish central bankers may also reignite investors’ concerns about the high inflation rates. Despite the sharp rise in consumer price indices around the globe, they haven’t even nearly kept up with the increased costs faced by producers. Should demand slow more sharply in the face of war-related uncertainty, this could also weigh on the prospects for corporate margins and thus force a more cautious stance from investors.

So we believe that the war may delay, but should not derail central banks’ plans. After some dovish remarks from the ECB’s Rehn, markets pared back their rate hike expectations for 2022 completely. And the fact that not only Bunds, but also peripheral yields dropped sharply indicates that traders may also have reassessed the prospect of more protracted asset purchases – or at the very least that they have priced out the possibility that Lagarde will announce that the ECB will end its net purchases more quickly.

Day Ahead

Similarly, markets also lowered their expectations for a potential 50bp move by the Fed this month, even though the economic damage will probably be less in the US than in Europe. Fed Chair Powell testifies to the House today, so it may be his turn to reassure markets that the Fed will not lose sight of inflation.