Why euro and sterling traders, not stock investors, should most fear the Ukraine crisis

<p>Stock markets around the world opened in negative territory on the back of the latest news out of Ukraine. Russian troops have moved to secure […]</p>

Stock markets around the world opened in negative territory on the back of the latest news out of Ukraine. Russian troops have moved to secure positions in Crimea, increasing tensions with the G7 and the Ukrainian temporary government. Investors typically hate political tension, particularly ones where Russia has been pit against the US and Europe. In that sense, it’s easy to translate why stock investors have moved to reduce their exposure to risk today, with the FTSE 100 and DAX both losing between 1.4% and 2.5%.

If the DAX closes lower by more than 2.55% (at the time of writing, it is on track to do so), it would be its second biggest one-day decline since April last year.
Yet, perhaps looking at the 2008 war between Russia and Georgia, where gas pipelines and a similar hostile protective stance was adopted by Russia, there is more to fear in terms of risk aversion in currencies than stocks which could spell danger for buyers of sterling and the euro.

A brief look back at the 2008 Russian-Georgia war: beware FX risk

In 2008, when hostile tensions between Russia and Georgia culminated in a pre-emptive strike by Georgia over the South Ossetia region, stock markets initially suffered weakness. Global indices including the FTSE 100, Dow Jones and S&P all lost over 2% in the space of 48 hours trading. But that was it. All indices quickly recovered their losses well before the ceasefire, which was announced on 12th August.

It’s a different story entirely when you look at how currencies reacted. EUR/USD fell from 1.53 to 1.48, a movement of 3.4% or over 500 pips, whilst the
GBP/USD pair also fell 4.6%, or over 900 pips. The US dollar index rallied 4%.

Risk currencies were sold aggressively, not stocks.

FX risk off

There remain fundamental reasons as to why we could expect much of the same this time around and why the case for a bullish Yen and Swiss Franc could be further cemented. Investors in stocks and risk-on currencies are finding other asset classes to recycle funds into. Apart from defensive stock sectors such as tobacco and pharmaceuticals, where else can they put their money? The Japanese Yen remains the most bullish of the major currencies year to date, whilst the Swiss France is also in demand through it’s lack of euro-connections to the Ukraine crisis. Gold has also seen demand in the last few trading day’s too as an alternative defensive asset class for the flow of risk off funds.

The Ukraine crisis

The crisis in Ukraine remains the key focus of the markets not for what is currently happening, but for the potential of what ‘could’ happen. Ukraine itself is tipping into a civil war, and Russia’s military has taken control of the pro-Russian Crimea region, which also contains a major Russian naval base.

This crisis has similar hallmarks to that of the Russia-Georgia conflict six years ago and if anything, that testifies how quickly and aggressively Russia will protect its assets and ‘citizens’ (or those that speak native Russian). The example of the world’s response to the Georgian conflict insinuates that we can expect nothing other than a tough rhetoric from the West and UN, and action from Russia. That result has already been played out to a degree and it’s hard to see the G7 calling Russia’s bluff at this stage, with definitive action to curb its military intervention in Crimea.

Should stock investors still be concerned?

Absolutely.

1. The potential of the situation to deepen and intensify remains large.
Russia has been known to be unpredictable in the past and its aggressive and quick action in the region, along with parliamentary backing for further troop deployment not just in Crimea but the Ukraine as well, shows that it remains steadfast to increase its presence in the region. Russia has historically shown that it will protect its assets and people without hesitation. This is exactly what it is doing.

2. The reaction of the G7 is crucial.
Do they call Russia’s bluff? Even if Ukraine strikes at Russian troops in the Crimea region, it will still be the response of the G7 that holds the key for complete market volatility and fear. It’s hard to see at this stage, with Russia holding all the cards, for the west to dramatically do anything other than appease Russian aggression.

3. A quick look at oil prices shows the impact this situation could have.
Nymex front month oil futures prices hit their highest level since September last year, hitting $104 a barrel. Further oil price rises will have a knock-on effect on stocks and sectors that rely on a stable oil price to keep fundamental costs down. Rising oil prices is a direct threat to the ability of stocks to rally in the near term. This needs to be watched.

4. Key indices have also hit major resistance levels and so the crisis could give investors the excuse they need for a 5%-10% market correction. Market corrections are healthy for the long term bullishness of major indices and as such, should not be feared. However, with the FTSE 100, DAX and Dow Jones all recently hitting levels which triggered selling, a small price correction could now be due. So if anything, the timing of the Ukraine crisis may have well triggered the inevitable.

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