Monday, August 11, 2014

Benign to malign

Benign to malign

For 25 years , since the fall of the Berlin Wall, markets have experienced a generally benign geopolitical backdrop. There have been sources of uncertainty - Iraq, Iran, Al-Qaeda - but overall the political backdrop has been supportive of equities and equity valuations. The question facing investors in the wake of the Ukrainian crisis is whether ( continued )

Saturday, August 9, 2014

A quieter week ahead ?

Summary : 

Russia seems to have backed away from escalation in Ukraine. Moscow thinks the advent of winter and a shortage of energy will bring Kiev and the EU to the negotiating table. Sanctions are seen as a sop by Obama to the McCain-Graham vocal right. Moscow sees a hike in oil prices to the $110 level is seen a useful counterbalance to sanction costs.

The 10% lightening of non-dollar assets put in place two weeks ago was timed right but markets may now rally. Time to buy EU non-banks.  

In the ECB the exit timing of Draghi increasingly  is tied to the failing health of Giorgio Napolitano the Italian President. Will Jens Weidmann replace Draghi ? Will ECB QE be €600 billion as touted by some IB's or something less ? Will the CC in Karlsruhe become involved ? 

For Obama the return to Iraq ticks all the boxes - allies are reassured, foes made to think again,  the Christian right quieted, oil exports from the Kurdish regions secured and markets reassured. Sisi has arranged another ceasefire in Gaza - one will eventually hold. In Iraq Maliki fired weapons against Mosul - Sunnis are coming to the opinion there is little difference between the Shia government in Iraq and the Caliphate. Al-Qaeda is the real winner.

Markets could fly if Xi and Abe reach agreement over the Sakuku's at APEC in November. With ECB QE more likely sooner rather than later if Draghi moves to the Lateran the bull run could pick up steam again even as Dr.Yellens mood music fades.

In the EU Juncker is under strong pressure to appoint the Polish FM Radek Sikorski as the new Representative for foreign affairs. Italy strongly opposes this.

Ukraine : There was a time last week when Moscow's Federal Security Council gave serious thought to sending in Russian ground forces in a ''humanitarian peacekeeper'' role . Markets reacted strongly to this fresh fear with sharp declines in the DAX and CAC 40. However, by Friday there were signs that Putin had backed away from escalation and was content to stick with its initial strategy - use Spetnatz troops to keep the rebel uprising from being defeated and wait for the onset of winter to starve Ukraine of energy and bring the Kiev government to negotiate. Moscow has taken the view that sanctions have less bite than expected and are primarily designed to appeal to right wing critics in both houses.

Putin's domestic popularity remains high. The government is united in its view that EU or NATO association for Ukraine is a strategic threat to the Russian Federation that cannot be allowed to happen. The sanctions have proven to be an irritant in the near term coming on top of a slowing economy - private pensions have been diverted to the State Budget as they were in 2013 and there are discussions about the reintroduction of mild exchange controls for foreign owners of certain classes of domestic debt - but the CB believes that by November higher oil and gas price should provide a net benefit to the balance of payments. The ban on imported agricultural products ( a $12 bn a year business ) can largely be covered by the use of imports from New Zealand, the RSA and SE Asian middlemen. Bank financing doesn't become a major issue until 2016 although second tier equities are heavily exposed to western financing.

The Security Council has opted for a mild version of autarky although wiser voices amongst its members are doubtful whether this is achievable. Some analyses show non-resource sector ROIC turning negative in 2015 without additional state orders and backing. The governments goal nonetheless marks the end of 25 years of accelerating Russian integration into the global economy. 

Iraq: Interesting development . Obama was almost forced into intervening as a signal to Russia and China ( and America's increasingly nervous allies ) that Washington had not turned its back on global events. Markets may well view this intervention as being a net positive.

Japan - China : The Diaoyu-Senkaku island dispute still our major worry. Beijing is unlikely to act by force in the immediate future but there are those in Beijing who would like to see a removal of this bottle neck by the time the new series of deep water Jinn SLBM's are fully operational by decade end. The waters near th disputed islands, the high seas of the western Pacific and the airspace over the East China Sea are all vital for the PLA Navy and CCG deployment of these new assets. Blue water contact with the Contact with JDF forces is increasing . Japan insists on its rights to international waters, the PLA has demonstrated its commitment to keeping foreign vessels and aircraft away from its units. Although a Code for Unplanned Encounters at Sea has been discussed Beijing say that the political environment prevents it being formalised. We would need to see a Xi-Abe meeting at the APEC summit in November to feel comfortable that tensions are being reduced. A succesful meeting could see a sharp turnaround in Far East flows out of risk assets with new highs across all asset classes.

The Vietnamese standoff with Beijing was resolved by the Chinese withdrawing an oil rig from Vietnamese waters an by Hanoi delaying a provocative ( in Chinese eyes ) trip to DC by their Foreign Minister. There is no sign of such sensitivity in Chino-Japanese relations. This is the issue that if left unresolved could cause markets to fall 50%.

Scotland : Gilts traders will be happy that the first debate went so convincingly to the pro-Union camp. A second debate on July 25th is likely to be more evenly matched. The pro-Independence parties have started on a major canvasing campaign in the poorer , traditionally non-voting, areas of the Central Lowlands. We stand by our long term forecast of a 54-46 vote in favour of staying within the UK. However, the pro-Union sentiment is arguably now at its high point.

ECB and QE : Jens Weidmann continues to manoeuvre to replace Mario Draghi at the ECB. A recent health scare with Italy's President Napolitano has raised the likelihood that Draghi may step down from the ECB and take up the position of Italian President sooner than summer 2015. Paris and Madrid have been canvassing to see what other states might object to a German at the helm of the ECB - Italy in this instance could hardly object. Prime Minister Renzi continues to believe that constitutional reform ( and a new President ) are necessary if lasting change is to be implemented in the Italian economy. Markets may not be a lenient inn their time horizons. 

Gaza : A tragedy but as long a Egypt and Saudi provide covert backing for Israel the situation remains containable. The larger issue of Iran's place in the mid-East remains uncertain. US and UK military action in Iraq is a sign to Tehran that resistance to their policies is increasing. What this means for the stalled nuclear negotiations remains dependent on how Russia responds. Moscow has sold S-400 air defence batteries to the PRC. Will they follow up with a sale to Iran ? this would make the country's nuclear facilities a no-g0 area for the Israeli Air Force.

Cuba : The government is actively courting both Moscow and Beijing to replace Venezuela as its major source of capital. This is a win win for China but stymies any hopes there were for the Obama administration to east the trade embargo.

Early event alerts 

Frank-Walter Steinmeier and Vice Chancellor Gabriel have had to put on hold hopes for a Berlin-Moscow-Paris alliance. However their reluctance over sanctions raises questions as to whether NATO is fit for purpose.

Baltic States watching developments are wondering whether €uro accession provides the security guarantees that they had hoped for.

Tuesday, June 24, 2014


Oil stocks have had a nice run up on the uncertainty surrounding Iraqi production with WTI at 9 month highs. Barring a shock they're probably fairly valued at these levels. However, a shock may be what we get if fundamentalist militias export their vision into Jordan or Lebanon and elicit an Israeli response. Time to lighten but not go aggressively short. Rosneft, Lukoil and Gazprom have made up their post-Crimea sell off. The hidden story here may be the purchasing by Israel of Kurdish oil shipped via Turkey through Ceyhan to Ashkelon. For Turkey in particular the benefits of such a transshipment agreement could be meaningful in equity and FX terms. Some 2 million barrels are already said to have been transported this way with exports forecast to reach an annual rate of 20 million tonnes, some of which will be re-exported to Asia. 

In Europe the British Prime Minister seems to be failing in his attempt to stop the arch-federalist Jean-Claude Juncker from taking over the top slot at the European Commission. There are rumours that at Friday nights dinner in Ypres ( oh the irony of it ! ) he will use the '' Luxembourg Option " and demand that nothing perceived to be of such vital national importance can be taken without a unanimous vote. As they say in France ' bon chance '. Europes real problem is one of adjustment. Britain and France, the old Imperial powers, are seeing their economic and geo-political importance slip away. The Brits are ahead of the French in recognizing this. Germany is the natural aspirant to pole position but its recent ( ie last 150 years ) history makes it loathe to trumpet its ascendancy too loudly. Russia and China are of course delighted to see the EU rocked by a lack of unanimity; America less so.

Despite the Scottish Referendum and the increased likelihood of a British Exit from the EU entering the mainstream , Sterling continues to stick resolutely north of $1.69. The Canadian Dollar is also motoring against signs that further rate cuts are firmly off the table.

Monday, June 16, 2014

A new week

British Prime Minister David Cameron had hoped to rally more support for his blocking tactics against former Luxembourg Prime Minister Jean-Claude Juncker. In this he has been remarkably unsuccessful. The very real possibility now exists that Juncker will be nominated by 25 out of 28 governments and the United Kingdom ( together with Sweden and Hungary ) will find itself with an arch-federalist ( and presumably anti-British ) head of the EU. Ouch ! It has been a long time since the British Foreign Office has failed so miserably and the Brits ( never popular at the best of times ) were left so isolated in Europe. 

London is now desperately hoping that new Italian Prime Minister Matteo Renzi will swing behind the opposition to Juncker. Renzi is young, has a mandate for change and may be willing to see a reform minded President of the Commission emerge. As part of a deal being discussed the current ECB Chief Mario Draghi may be put forward as the governments candidate to replace ageing Italian President Giorgio Napolitano in two years time. Draghi's place would then be taken by Bundesbank President Jens Weidmann. 

With ISIS fundamentalists continuing to advance the US is left in a quandary. There are already signs that the Afghan Taliban are taking heed of what is happening in  Iraq. A US response will need to address not only the situation in Iraq but also the likelihood that a similar reversal may occur in Afghanistan. Expect drone attacks to signal a more hands on response. The resignation of PM Maliki would be a good signal to all parties that reform is belatedly taking hold.

Friday, June 13, 2014

Iraq and the oil price.

The capture of Mosul by the forces of Islamic State of Iraq and al-Sham ( ISIS) could lead to the dismemberment of Iraq. Certainly, the authorities in Baghdad seem unable to respond to the advance of the radicalised Sunni militias in an effective manner. This dismemberment is not something Washington wants. So it looks as if the US will need to reverse its planned withdrawal and increase the level of support it provides the government of Prime Minister Maliki. This is a strange turn of events as it now means that Iran and the US will be working to defeat the Sunni militants and  prevent the collapse of the Iraqi government in Baghdad. Iran is already organizing the arming and transfer of Shia militants from their heartlands in the south to the northern combat zone.

Washington is deeply unhappy. It finds itself sharing goals with Iran in Iraq while at the same time opposing it in Syria . Washington is also making  soundings to Tehran to achieve a breakthrough on Iranian nuclear capabilities. Pity the poor US ambassador in Riyadh who has to reassure his host government that American policy is working.

Expect 1) more US arms sales to Iraq - Apaches, 2) the use of missile equipped US drones to attack ISIS military concentrations, and 3) growing alienation between the Obama administration and Riyadh and America's other allies in the region. To confuse matters further disenchanted ex-military leaders from Saddam Husseins army are said to be making common ground with ISIS in the Ninawa and Diyala provinces. Fragmentation of the country into Sunni and Shia regions is now a real possibility. To top it all the Kurdish Peshmerga forces now find themselves faced with a new threat .

Iraq is OPEC's second largest exporter. Is it any wonder that the oil price has firmed ?

Monday, May 19, 2014

Off to China

Russia's President Putin is off to China this week. The usual defence contracts can be expected. More important will be whether landmark oil and gas deals will be signed. We don't think they will. Gazprom, Rosneft and LUKoil are all looking for alternative markets should sanctions over Ukraine continue. Getting oil and gas to China from Russia will not be easy - new pipelines will have to be built - but markets may put a positive spin on any agreements. From what we hear Gazprom is close to agreeing, or at least wants to, a 30 year deal at a fixed price of $380/MCM.  China, it is suggested, will pay upfront for a pipeline in return for fixed pricing - something Gazprom has so far been reluctant to agree to preferring an oil linked pricing formula as it has with Europe. Negotiations have taken 10 years to get this far. The Chinese are consummate negotiators. We shall see.

Tuesday, May 6, 2014

Ukraine again.

The headlines in the financial press continue to state that markets remain unsettled by unrest in the Ukraine. We're not so sure.  It's interesting to note that when we last wrote about developments there on April 8th the FTSE was at 6600. A month later the index is at a 6800 level. There have been Russia related right offs AND EARNINGS HITS - Carlsberg and Soc Gen being among a slew of companies that have seen slower Russian demand.

This isn't to say that developments in Ukraine are unimportant. The world ( and markets) could probably understand and live with a Russia that views a western leaning Ukraine as a threat to its security. NATO troops or EU officials on its border might e a step too far for the Kremlin. A neutral, modernized, country might then be a reasonable negotiated outcome. This could be beneficial to all parties, Ukrainians included. What is unsettling is whether Moscow's assertiveness marks a new strand in Russian diplomacy that wishes to intervene wherever there are 'threatened' Russian minorities. The scope for destabilization in the Baltics, Kazakhstan, Moldova, Georgia et al is something that would be profoundly more serious. As it stands we just don't know whether Moscow inspired instability in Eastern Ukraine is a post-Crimea one off , or is part of a larger and more serious change in strategy.

There are two other factors that need to be watched here. Mindful of mid-term elections and accusations he's soft on foreign policy issues, President Obama is slowly responding to Moscow adventurism by ratcheting up sanctions. Although America's diplomatic steps have been incremental and serious there is always the possibility that Congress will look for faster tougher responses. 

A second factor relates to Germany. There is much soul searching in Washington over Berlins unwillingness to support a stronger response to Russia's flouting of the recent Geneva agreement. Former Chancellor Schroder celebrated his 70th birthday with President Putin last week - a symbolic act that was well received in Moscow but raised eyebrows in London, Washington and Paris. Growing anti-Americanism in Germany is now an issue.

With Ukrainian elections scheduled later this month the conflict between Kiev and Moscow for control of the country enters a new, and heightened, phase. Moscow must decide this week whether to intervene while its forces remain on high alert or let the situation continue while western sanctions take effect. Markets will be alert to the loss of earnings and reduction in visibility that comes from tightening sanctions. Austrian banks and companies will be particularly impacted.